Money management should be near the top of the list when you think of important lessons to teach your children. Many parents acknowledge the importance of teaching their kids about budgeting, and instilling in them a solid work ethic. What’s a little more complicated is teaching your children about matters of higher finance, like interest.
While you aren’t going to be able to teach your five-year-old about borrowing money and how investing can result in earning through compound interest, most teenagers are capable of understanding these concepts. “These are really important concepts for people to learn and be comfortable with early,” says John Sweeney, the Executive Vice President of Retirement and Investing Strategies at Fidelity. “The more we can familiarize kids early, the better off they will be.”
So, how can you teach your teens about interest? Sweeney says it’s easier than you think — as long as you are willing to engage your children about money and their choices regularly.
Back to basics
Before you start talking to your kids about interest, Sweeney says you need to lay a good foundation. This means going back to basics. “The first thing to talk to kids about is spending and budgeting,” he points out. “It’s quite tangible for them.”
Sweeney talks about the bike he bought, with his parents’ help, when he was 12. “I still remember how much that bike cost,” he says. “My parents had me lay out ones, fives, and tens on the table. We talked about the things I wanted in this bike, and the value of different features. I learned about tradeoffs. If you want to upgrade, you have to pay for it.”
This type of visual and engaging lesson is one that kids can begin learning at a young age. Laying this foundation starts an early relationship with money. If you haven’t already helped your child learn how to save up for goals, or think through purchases, those are the subjects that need to be covered before you can move on to something as complex as interest.
Interest paid vs. interest earned
Once you’ve laid that solid financial foundation, you can move beyond the basics. Sweeney points out that information is readily available online, and many kids can easily learn lesson with the help of the Internet. “They can go online and see what homes in your neighborhood cost,” he says. “Then, you can put that into context of what people actually earn.”
Sweeney says you can move on from there to talk about how borrowing requires you to pay interest. There are numerous online calculators that can help you illustrate the impact of borrowing and the cost of interest over time. “You need to talk about the importance of borrowing as little as possible, and show them how they should be able to repay what they borrow.”
While touching on responsible borrowing is important, Sweeney really likes the idea of getting teens interested in earning interest. The first step, he says, is opening a savings account so that they can see how they make money just by letting it sit there for the bank to use. Most teens can grasp the idea behind using your money to make loans to other people, and paying you for its use.
The most important interest-related lesson for teens to learn, however, deals with investing. “Most teens are familiar with the fact their parents work for someone else,” says Sweeney. “When you tell them that they could have everyone involved with a brand working on their behalf, that interests them. The concept of becoming a shareholder comes to life for young investors.”
Sweeney suggests having your teens suggest some investing ideas and then researching those companies together, to see if they make sense. He also points out that many web sites allow you to put together watchlists. These watchlists can be great resources. You can track a company’s performance, and news about the company, and talk about how, over time, all of the compound interest earned adds up to a great deal.
“Behaviors change when concepts become tangible and real,” Sweeney says. “If you can connect investing to favorite brands, and demonstrate the effect of time, you can set your kids up for better habits.”
Don’t forget to talk to your kids about the pitfalls of investing, though. “Talk to your kids about mistakes as well as successes,” Sweeney says. “Not every security goes up. Talk about why, and that it doesn’t always work out. This can help you talk to them about choosing a mix of different types of investments so they aren’t putting all their eggs in one basket.”
Many of these ideas can be applied in my own dealings with my son. This year, I opened a custodial Roth IRA for him for his earnings doing administrative work in my home business. When he was able to look at his account recently and see the impact of investing, and how a $70 investment had turned into $90, he was very excited. Over time, these gains compound, and he’s beginning to understand this.
“Get a generation of kids to begin thinking this way, and we’ll make huge strides for the next generation,” says Sweeney.