Teaching Financial Responsibility to the Next Generations

Among the most important life lessons parents can teach their children is the value of money and how to manage it wisely. Once they leave college, everything they know about money will guide their financial decisions in the real world. Unfortunately for many kids, some of the most important financial lessons are learned through trial and error, which can be very costly.

Understanding the most fundamental principles about money and the importance of financial responsibility can mean the difference between living their young lives fruitfully or forever burdened by debt. Here are five basic principles that parents can teach their children to give them the best chance of financial success.

Money Doesn’t Grow on Trees

It starts very early when you look into your child’s eyes and tell them that money doesn’t grow on trees but is earned. You should introduce the concept of earning an allowance as soon as your child is old enough to do some chores around the house. From that point forward, the money they receive from you should be tied to something they did to earn it. The allowance amount should be based on the extent of the chores and your child’s age.

For example, $10 per week might be appropriate for a tween, while $20 is sufficient for a teen. You can increase the allowance as their responsibilities increase. By the time your child is 16, they are old enough to look for a weekend or summer job, especially if he expects to drive the family car or get his own car.

Budgeting, Tradeoffs, and Savings

This is your opportunity to teach your children the responsible use of money. They should be able to spend their money on anything they want within reason, but they should also understand the importance of budgeting, tradeoffs, and savings. This is the time when they learn about tradeoffs. If they spend all their money on one big thing at once, they won’t have any money for the smaller stuff they want regularly. Conversely, if they continuously spend their weekly allowance on small things, they won’t be able to save money for the big things they want.

At this point, they need to learn about setting goals and prioritizing their spending. Sit down with your children and help set goals for things they would like to buy. Help them work out a spending plan that will enable them to allocate their money between what they want to spend each week and what they can save towards their goals. You will be amazed at how quickly they latch on to this idea and the pride they feel when they reach their goals.

Pay Yourself First

This is a fundamental principle of personal finance that, if learned early, will guarantee financial success for your children. Many people make the mistake of planning their savings around their budget, meaning they save whatever is left over after paying all their expenses. For people living on a tight budget, this often means that nothing gets set aside for savings.

The only way to guarantee you can stick with a savings plan is to pay yourself first. That means planning your budget around your savings goal. If your teen has a goal of saving $1,000, they could reach that goal within a year by saving $25 a week. If they earn $100 a week at a part-time job, they will pay themselves first by having the bank automatically deposit $25 in their savings account. If they set a goal of $5,000 to buy a car within two years, they could reach that goal easily by saving a little over $200 a month.

How to Become a Millionaire

If you really want to get your kids excited, show them how easy it is to become a millionaire. This is where you introduce the concepts of compounding money and the value of time. You can get their attention by showing how compounding works.

Give them a hypothetical choice between a receiving penny that doubles its value each day or $10,000 in cash and ask them which will be worth more at the end of one month. Most kids would choose the cash, but they would feel pretty silly when they learned that the doubling penny would be worth over $5 million!

That’s the power of compounding. Now, use the same concept to show them how to become a millionaire by age 65. For an 18-year-old, it would take just $250 a month or about $65 a week in savings, earning 7 percent (the historical average return in the stock market) to save $1.1 million. It’s not just the $250 monthly savings that is accumulating; the returns accumulating on top of returns over time create most of the wealth. When children learn that time is their most valuable asset, they may not want to waste it.

How to Master Credit

For most of their young lives, your kids have watched you whip out your credit card like magic. So, it’s tough to tell kids that credit is bad. They should know that credit can be good when used wisely. Most kids don’t experience their first use of credit until after they leave college. If they don’t learn about it from you, they’ll learn about it on their own, which doesn’t always end well. Introduce your children to the use of credit early on and teach them how to use it responsibly.

Start them out with a secured credit card, which uses a savings deposit as the line of credit. They should only use it to purchase things already in their budget and then pay the balance in full monthly from their earnings. It will help them build their credit, and if they can demonstrate a year or two of on-time payments and proper credit utilization, the bank will offer them a regular credit card. By then, they will have mastered the good habits of using credit.

There’s no denying that teens have short attention spans, and many would just as soon enjoy their young lives as become adults in training. However, given the chance to gain increasing financial responsibility as a contributing member of their family enterprise and an opportunity to gain more control over their own personal finances, they just might surprise you. Remember that it’s a learning experience and that good financial habits are among the hardest to develop (ask any adult).