Learning the principles of investing is important at any age.
They say it is never too late to start investing but there are a million reasons ($$$$) to teach these principles to your children as early as possible.
While teaching financial concepts to kids can be a challenge, with patience, persistence, and some clever tactics we believe you can help your children or grandchildren begin their life with a firm financial foundation.
1) Compound Interest
I first learned about compound interest in an Economics class in high school. It was one of the reasons I was so intrigued by finance and investments. Thank you Mr. Jominy!
It is the greatest asset in the financial world and when used properly can create generations of wealth.
For example, let’s say we have two individuals James and Ronda, both 18 years old and living in the Bay Area of California.
At 18, Ronda opens up a Roth IRA and faithfully contributes the maximum amount of $6,000 a year until she is 65. James doesn’t start contributing to his Roth IRA until he is 28. If their investments averaged 8% a year, Ronda would have almost $3MM while James would $1.3MM. Waiting 10 years cost James $1.7MM!
Compound interest is critically important.
2) Risk and Return
The basic idea with risk and return is that there is a tradeoff between the two.
The tradeoff states that the potential return rises with an increase in risk. But with the increase in risk, so does the risk of losses.
You can start this conversation with your children with a general discussion around stocks and bonds.
Stocks are considered a risky asset in the investment world but along with that risk comes the potential for higher returns. You can show that an individual company’s stock can fluctuate depending upon the growth and profitability of the company.
Use a company you are familiar with, maybe Apple, Amazon, or Disney.
Make sure that you communicate that with stocks there is always the potential that the stock you buy could be worth nothing if the company files for bankruptcy or suffers from fraudulent financial statements.
In general, bonds are fairly low risk assets and have lower returns as a result. While you can buy “junk” bonds that carry more risk than a highly rated bond, many bonds are backed by banks and governments making them safer assets.
Here is a great video from Khan Academy
Understanding diversification can help maximize your risk and return decisions.
Diversification is the idea that spreading your investments across a wide variety of asset classes and types of companies within a portfolio. You are effectively investing your money in many different things instead of investing all of your money in a few things.
Diversification smooths out the risk to the portfolio so that positive performance of some investments could negate the negative performance of others.
Let’s look at an example. Say Jenny and her family owned $1MM worth of Apple stock while Brittany and her family owned $250K of Apple, $250k of Paypal, $250k of Nike, and $250K of Ford.
Hypothetically, If Apple’s stock drops 50% because of problems with the latest iPhone release, Jenny’s $1MM would be worth $500K. But Brittany’s portfolio, assuming her other holdings had stayed the same, would be worth $875K.
Of course you could also diversify by investing in different types of asset classes such as stocks, bonds, and real estate.
4) Long-term Focus
“The stock market is a device to transfer money from the impatient to the patient.”
Investing for the long-term should be an investor’s primary goal.
Compound interest has very little power in the short-term but it has great power when you give it 30 – 40 years.
Having a long-term view on investing can help to alleviate the stress of short-term corrections and setbacks in the market.
One of the investors’ worst enemies is fear. If you are more forced on how an investment will perform in the short-term as opposed to the next 20-30 years, then short-term instability could bring a lot of stress, anxiety, and ultimately losses to your investments.
But, if you are focused on the next 30 years, short-term volatility won’t phase you. You will spend more of your mental power enjoying life and if you are a truly savvy investor, you will see short-term corrections as a great opportunity to buy!
“The intelligent investor is a realist who sells to optimists and buys from pessimists.”
5) Make it a Habit
Helping your children understand the power of investing and savings wouldn’t be complete without teaching them good investing habits.
During their weekly allowance distribution would be a good time to discuss what portion of it goes to savings/investing and which portion they can spend.
You could have monthly savings goals that you review with your children every two weeks.
If you are working with a financial advisor, have them help you set up family savings goals as part of your comprehensive financial plan and invite the family to sit in on part of your review meetings.
The important thing is to keep “savings” and “investing” top of mind to create good financial habits as early as you can.
To show the cost of bad savings habits, let’s take a look at a quick example.
Daksh and Ishir are two brothers working in the technology world in San Francisco. From the age of 18 Ishir has been habitually contributing to his Roth IRA and his individual investment account. He contributes $6,000 per year to his Roth IRA and $3,000 per year to his Individual. Daksh is much less habitual about investing. He averages $2,500 every year and contributes $1,000 per year to his Individual. If their investments average return is 8%.
In 30 years, Ishir will have a Roth IRA worth around $734,000 and an individual account worth $367k, with a total value around $1.1MM. Daksh will have $305K in his Roth IRA and $122K in his individual account, totaling $428K in investments.
Good habits can make all the difference in the long-run!
6) Make it Automatic
Automating savings and investing can be a powerful tool.
Depending upon the age of your child, you can help them establish a custodian Roth IRA and set up automatic transfers from their bank account to their Roth IRA based on their earnings.
You can also automatically put a percentage of their allowance, birthday money, and Christmas money into an investment account.
Making it automatic makes investing and saving an easy habit to create.
7) Pay Yourself First
This is one of the golden rules of investing.
It is golden because if properly stewarded, it will teach your kids how to separate themselves from the majority of Americans that don’t have $250 saved.
The idea is to prioritize savings and investing for your future before you pay your bills, grocery shop, or buy that new Apple watch.
Personally, I automate my savings to automatically have part of my income go into an investment account. This ensures I save and invest first prior to spending.
The major benefits of paying yourself first is that it actually builds a powerful layer of protection for your current and future financial foundation.
If you don’t have any savings because you prioritize savings last, then if emergencies come up you might have to put those expenses on a credit card or even dip into invested funds.
These types of choices will only lead to loss of investments and greater expenses if the credit cards are not paid off before interest is charged.
Having a savings account allows you to pay for unexpected expenses with cash, eliminating the need to build credit card debt or cash out investments, lowering the impact of compound interest.
Paying yourself first also ensures that you are focused on saving for your retirement. Even if the retirement isn’t for 30-40 years, starting to prioritize, build, and protect your retirement savings ensures that compound interest has the freedom to work powerfully in your financial life.
Helping our families understand these 7 investing principles can empower them to maximize the ability of investing in their financial future.
If these lessons seem like they are difficult to grasp or your kids don’t seem too interested, be persistent.
Just like investing, don’t be too worried about short-term corrections and set-backs but be consistent over the long-term.
Whether they realize it or not, your children will learn this stuff, especially if their parents are modeling it for them.
Meet the Contributor
Zack Swad is a fee-only financial planner located in Santa Rosa, CA serving clients locally and across the country (virtually).
He specializes in financial planning and retirement planning for people age 50+. As a fee-only, fiduciary, and independent financial advisor, Zack Swad is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice. He has been in the finance industry for over 11 years. He previously worked for a Fortune 500 Financial Services company, managing a practice of $800 million for 300 clients. Zack then went on to build his own firm, Swad Wealth Management, LLC so he could make a deeper impact in his client’s lives. In his free time, Zack enjoys spending time with his wife Elise, playing board games, piano, and singing.
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This commentary on this website reflects the personal opinions, viewpoints and analyses of the Swad Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Swad Wealth Management, LLC or performance returns of any Swad Wealth Management, LLC client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this article constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Swad Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.