Photo: Dmitry Lobanov (Shutterstock)
If you’re a parent, I’m sure you’re trying to teach your child to save their money—but if you want to set your child up for a deeper level of financial success, you have to teach them the difference between saving and investing. This early lesson in financial literacy could be the difference between a comfortable nest egg and financial hardship later in life.
The difference between investing and saving
The concept of saving vs. investing is simple enough: Saving is gradually putting money aside, usually for some specific future purchase or as a cushion in case of cash-emergency. Savings are virtually risk-free. Investing, on the other hand, is putting money aside for the sole purpose of making more money, and it involves some risk.
Saving is easier to illustrate to a child than investing, Kids understand a piggy bank, that if they put a portion of their birthday money into a savings account for a couple of birthdays, they’ll be able to afford a bigger toy they want, so it makes sense to introduce that to them at a younger age. Investing is a more abstract concept, as it involves pooling your money with others and participating in financial markets that can be difficult to picture. It also involves longer-term thinking, and the idea of an intangible reward in the far future. “You’ll be able to pay for a good retirement home” isn’t too compelling to most 12-year-olds.
When is your child ready to learn about investing?
According to Melanie Mortimer, head of the foundation at the Securities Industry Financial Markets Association, kids in the fourth grade are ready to learn about investment markets. “When you’re 9, 10 years old, you’re learning about fractions; you’re learning about decimals…The idea that you can take something very small and grow it to be something much larger is very compelling for them,” Mortimer told Yahoo! Finance.
How to illustrate investing to a child
For younger kids, the website wealthify suggests using a lemonade stand as an illustration of how investing works. The investors (the parents, in this case) lay out the money for the lemons and sugar. The kid stands in the hot sun and does the labor while the parents relax. If the stand makes money, the parents get their investment back and a little extra. The kid’s profits can be put into lemons and sugar to cut out the investors, or kept, and the investors can add more money to hopefully make a profit the next day. If the stand fails, the parents, having assumed the risk, lose their initial investment, where the kid loses only the time they spent selling lemonade.
Don’t throw your kid into the stock market until they’re ready
A bare-bones understanding of investing through a lemonade stand is a good start, but when your kid gets a little older, you need to introduce them to the shared risk and reward of the financial markets where they’ll likely be putting their actual money.
It might not be a good idea to jump right into the Dow Jones or NASDAQ. Some people suggest letting your kid pick out stocks they like and actually buying a share or two, and tools and games like The Stock Market Game, a website that allows you to create a portfolio of stocks to see how you’d do in the actual market had you purchased them, can spark a kid’s interest and give an understanding of basic market concepts. But in real life, investing by picking individual stocks is usually not a good idea.
As this Yahoo! Finance article points out, for kids, you should start with a grounding in basic financial concepts like inflation, risk vs. reward, and compound interest. The basics of investing are not as sexy as buying a thousand shares of GameStop and selling before the bubble pops, but real life is likely to be about putting part of a paycheck in a 401K plan rather than high-risk financial instruments—boring but dependable.
If your kid is fascinated with money and investing, like a future Warren Buffett, they’ll have a lifetime to learn the intricacies of capitalism (Also, congratulations! Play your cards right and you’ll end up in the good assisted living facility.) But for most kids, basic financial literacy should be enough to get them through life and keep them from throwing their money away. Actually instilling investing as a habit is more difficult but probably more important than deep market knowledge.
Teach your child to pay themself first
The habit of investing money could be the most important gift you give your child, so try to drill it into their skull.
Experts generally recommend using 10 to 20% of your income for investing, and they can open a Roth IRA as soon as they start making an income, even just by babysitting or mowing lawns. Stress that this money is only for making other money. It’s not for buying anything, and it’s not for waiting for a rainy day.
When budgeting with your child (you do budget with your child, right?), teach them that this 10% is paid first. You want them to understand that this is a payment to themselves. It isn’t an afterthought or something you do “when you can;” it’s a requirement. Point out that they probably won’t notice a measly dime off of a dollar immediately, but when they retire, they’ll be amazed that they’re rich.
Take a second and really imagine if you had done this consistently yourself (I didn’t either) since you first started earning money. Do the math: 10% of everything you have ever earned, a return rate of 8-10% yearly, and 50 or so years of compounding interest. It’s a heartbreaking amount of money, isn’t it? If you earned only $12 an hour for your entire working life, you’d still be a millionaire when you retired.
