4. Good Financial Responsibility Means Managing Financial Tools Well
Kids who start budgeting with cash from an allowance often find it hard to make the transition to checking and savings accounts, credit cards and the idea of investing. It’s your job to teach your kid how to use these financial vehicles responsibly.
Best Approach: Godfrey suggests these three tacts:
1. Checking and Savings: Set your kid up with a savings account around the age of five. (Learn more about the ins and outs of opening a custodial savings account for your kid.) Even though most banking is done online these days, it’s important to physically take him to the bank, so he can see where his money is going–and that it’s in good hands.
Once he’s opened a checking and savings account, pay your child his allowance in check form, and go to the bank together to deposit it. Then open an online account together, which you can monitor, and explain how online banking works. You can even reserve his savings account for different categories–charity, medium-term savings or long-term savings–so he can get the satisfaction of watching the numbers go up with each deposit.
2. Credit Cards: Once your kid proves that he can manage the basics–he’s held a summer job successfully, saved up a certain amount in his savings account, has never overdrawn his checking account–set him up with a pre-paid credit card, ideally around the time that he’s set to leave for college or take a full-time job. Pre-paid cards are good because they work like regular credit cards, but your child won’t be able to accrue debt, since these cards have a set spending limit.
3. Investing: Godfrey says that you can introduce the concept of investing around the age of 10. “Start by finding stores and companies your kid loves, and purchase small amounts of individual stock for her, so she can watch it grow,” advises Godfrey. “As she gets older, explain the idea of finding companies and products that are recession-proof and why that’s so important when it comes to long-term investing.”
A note from LearnVest Certified Financial Planner (CFP) Brandie Farnam: “Owning a little bit of stock in a company that the child likes can help teach the concept of ownership and volatility, but focusing on the stocks themselves is emphasizing the wrong part of the process. It ignores the most critical aspects of successful investing–choosing an appropriate risk level for your goal, and diversifying your portfolio.
So I’d encourage parents to make sure that their child isn’t left with the impression that successful investing is about picking stocks. Instead, try to introduce the important concept of diversification and not putting all of your eggs into one basket–the goal is to spread your risk across different types of investments.”
5. Everyone Has to Pay Taxes–Even You
Explain to your child that everyone has taxes taken out of their paychecks to keep things running smoothly in the country. Tell him that the salary he sets up for himself for his job–mowing the lawn, doing household chores–isn’t the same amount that he’ll be getting in his take-home pay.
Best Approach: Starting at age 10, put your kid in a 15% tax bracket and have him deduct that money from his allowance into the family tax jar, suggests Godfrey. “Of course, you’ll need to explain that, in real life, this money goes towards things like keeping our roads clean and safe, but at home, your family can vote on a quarterly basis how to use the tax money,” says Godfrey. “This will help avoid the freak out later when he gets his first paycheck and he’s like, ‘Who’s FICA, and why is he taking money out of my salary?’”
Tell us: What are some other important financial conversations to have with your kid?