Financial advisers spend lots of time explaining investing principles like diversification, compounding and dollar-cost averaging to clients. But how do they explain these investing fundamentals to a more personal audience—their kids, and at what ages?
When money matters become part of the dinner-table conversation, raising investment-savvy kids can be as simple and painless as filing a 1040EZ.
Here are some tips from financial professionals to parents on how to teach their children about investing.
Start the conversations early
Judith Ward, a senior financial planner with a unit of T. Rowe Price Group Inc., started early and kept things simple, every step of the way. She opened savings accounts for her kids when they were in elementary school. They went with her to the bank to make their deposits and reviewed monthly statements with her.
"They could see what they put in, the interest that was earned," Ms. Ward says. "We would have a conversation about that."
As the children grew older, she shared with them her paychecks and investment statements, and explained how every little bit—deductions included—helped to feather her retirement nest egg.
And recently, when her son, Justin, now 23, opened a retirement account for himself, she says she talked to him about how much he should put in on a monthly basis, and about the benefits of dollar-cost averaging—although she didn't use that term, she adds. Ms. Ward says she simply explained that if he invested every month, whatever the market was doing, he would get fewer shares if the market was up, but more if it was down.
Have them invest in companies they understand
Some parents start their children investing in elementary school. Jason Moser, an analyst with Motley Fool, an online investment-research company based in Fairfax, Va., says he introduced investing to his two daughters, Hannah, 8, and Ainsley, 6, two years ago when the family stopped at a Panera Bread Co. for lunch. Mr. Moser says he casually mentioned to his daughters that "we own a little bit of this restaurant."
Their quizzical looks led to an explanation of stock ownership, he says. "They thought that was really neat. Panera was not just a restaurant, but something we as a family are vested in," Mr. Moser says.
Mr. Moser advises parents to frame discussions about investing as buying into companies the children know and understand. Every quarter, his girls pick one stock in which to invest. His only stipulation is that they buy a different stock each time to learn the value of diversification. Their first pick was Starbucks Corp. Last quarter, they bought Apple Inc. Mr. Moser funds the account with a few hundred dollars every month. The girls pitch in, too—with birthday money or tooth-fairy money—"just to give them a sense of ownership."
By late elementary school and middle school, children can grasp compound interest and how money grows, says Ms. Ward, who has taught high-school students how to handle and invest money. Middle to high school is the time to explain investment vehicles such as stocks and bonds, she says.
Teach them about inflation before they start investing
Some experts argue, however, that for children to really appreciate the importance of investing, another lesson must come first. Ann Minnium, a principal at Concierge Financial Planning in Scotch Plains, N.J., says children need to understand about inflation before they start investing. While students quickly grasp that people can make money by investing, Ms. Minnium says, they have a harder time understanding that investing can be necessary to prevent inflation from eating away at their savings.
Ms. Minnium has a software program with an "inflation calculator" that she uses to show kids how money tends to lose purchasing power over time. She also uses a chart from Morningstar Inc., she says, which shows market returns since the 1920s, and how purchasing power is eroded when bank interest rates are lower than the rate of inflation.
Let them take the wheel—within limits
After they've learned about inflation, kids can start experimenting with investing in their teens, Ms. Minnium says. But she cautions against giving them total freedom. Her son, George, 18, has a $600 investment account to which he adds $50 every month. Ms. Minnium says wryly that her son's investments are a mix of penny stocks and other shares "typical of an 18-year-old," such as companies that legally sell marijuana for medical purposes.
But she makes him limit stocks to 15% of his portfolio. The rest is an exchange-traded fund of her choosing, she says, one "appropriate for his age and objectives—long-term growth." It's a diversified fund, she says, comprising cash, U.S. and non-U.S. stocks, bonds and a low expense ratio of 0.11%. ETFs are great for young people, she adds, "because they can be into a fully diversified portfolio with just a small amount of money."
Once children start earning income, the next step is to open a retirement account. Ms. Ward says that her son, Justin, opened his Roth IRA as soon as he started to make a decent income. Such moments are ideal for parents to educate their kids about investing, Ms. Ward says, and pave the way for open communication about financial matters in the future.
Justin "asked a lot of questions" about the Roth, she says, particularly how taxes are treated. In a Roth IRA, returns on the fund's investments aren't taxed. "Now that he's faced with financial decisions," Ms. Ward adds, "he'll call and talk about it and ask questions, about college debt, for example. Just making them aware of these things will get them to take a little more interest."
Be ready to step in, and always reinforce good values
The financial pros say it is important that parents let their children make—and learn from—poor investment choices. But, Ms. Ward cautions, "you just have to make sure the mistakes they make won't derail them."
Similarly, parents need to ensure that their investment-savvy children don't turn into money-grubbing ones. Ms. Ward says she encourages her kids to support charities with their money and with their time. Her children join in on charity walks and other volunteer activities, for example.
"It doesn't have to always be monetary," she adds. "It's just as important to be involved in giving your time as writing a check."
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Originally published August 1, 2013
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The views of the authors of these articles do not necessarily represent the views of First Republic Bank.