If you want them to do well, you need to teach your kids how money works, period.
Unfortunately, schools do not teach children how money works and how to make it work for them. And so many children leave school with academic skills, but without any financial literacy. This is, in my opinion, the biggest flaw in our educational system today! And it’s why you need to help your kids understand how money works if you want them to do well financially later on in their life.
So the question we need to ask is “How to teach your child about money?”.
In this article, I will cover WHY it’s important to make sure your children are financially literate, what financial understanding they absolutely need to have as well as some concrete things you can do as a parent to teach your kids about money.
For full transparency, I am an economics major (soon to get a master’s degree), I’m an avid investor and an entrepreneur. What I am not, however, is a dad. This knowledge is coming from my financial education and knowledge about money, but they are the kind of lessons that I will definitely be teaching my children when the time comes. And the kind of education I wish I had as a kid.
Table of Contents
Why Teach Financial Literacy to Kids?
It is not enough for children to do well in school, get good grades, go to college and get a good job! The fact is that many people, even those with good jobs, are living paycheck to paycheck with little to no savings. This includes more than half of the people (in the USA) who earn between $50000 and $100000! For an estimated amount of 125 million US adults!
On top of that:
Many people are crippled by their student loan debt, credit card debt and other forms of payments. Many people seem to be unable to escape poverty. Meanwhile, the rich only get richer. The prime reason for this is that the rich understand how money works and how to make it work for them. They apply these principles of money and teach them to their children, while the poor have little to no knowledge on the subject of money.
In short, you want them to avoid the financial pitfalls ahead of them!
What Financial Knowledge Should You Teach Your Kids?
Now that you understand why you need to teach your kids about money, let’s cover the basic skills.
There are a few things you should do as a parent:
Firstly, you want them to understand that every action has consequences. I’ll cover this later when talking about how specifically to teach your kids about money. Many people take actions like using credit cards, taking on a mortgage or buying a fancy car with borrowed money. Most of the time while only having a partial understanding of the consequences of those actions.
How much money do you think you would lose out on if you had $1000 in credit card debt and you wouldn’t pay off a single cent for 10 years? And let’s say that the interest rate is 15%. Take some time to think it through and write it out if you want to.
Got an answer ready?
If you would leave that $1000 untouched for 10 years, you would have $4045.56 in debt after 10 years! Meaning that at 15%, your debt roughly doubles every 5 years! Many people grossly underestimate this. Which is why you need to make sure your children learn about the financial consequences of their actions.
Moving on, there are a few skills everyone should know before turning 18:
- The merits of saving
- How credit cards work
- Basics of investing
- How financial markets work
- Cash flow
- Assets versus liabilities
- Good debt & bad debt
How to teach your child financial literacy will depend on their age of course, but the basics will stay the same. The older a child gets, the more you can work towards a real-life situation, but while they are younger, teach your child about money through games and easy-to-understand situations.
How to Teach Your Child About Money
Alright, let’s get into the specifics of giving your kids financial education.
The first step as a parent is to not hand them everything they want. Of course, you will need to take care of their food, shelter, clothing (up to a certain age) and things like that. However, what I would recommend is to give them an allowance with which they can make their own decisions. If they want to buy toys, video games, candy or go do things with their friends, they will need to budget and save for themselves.
That’s the first step of teaching them about money.
If you just give them everything that they want, they will never learn how to make their own financial decisions. They will become spoiled and get used to having it all, using mommy and daddy’s “infinite pool of money” for everything. They won’t know what it’s like to earn money when it’s a limited resource.
Which brings us to the next question:
Should You Let Your Child Do Chores for Money?
Let’s say your child wants to go to the movies but lacks the money.
Will you let them do chores to make some extra?
There is no right or wrong answer here, just the lessons that you want to teach them as a parent. I know quite a few parents who tell their kids they can make some extra by doing things around the house. It’s definitely a good way for them to learn how much more difficult it is if you have to work for your money, rather than getting it outright. So it’s never a bad thing to do this.
However, it’s not something I would do personally.
So I’d like to offer you my alternative:
I’m an avid learner and do so every day still (always will), so my mindset is a bit different. So while my children will never get any money for doing chores, I will be paying them whenever they read a book (extra if they write a summary), if they show me their notes of lessons they learned from a blog post or video and things like that. In addition to opening their mind to hustling and entrepreneurship.
My reason is simply this:
The more they know, the better. If I can get my future children to love learning, they will win at life, period. Not only will reading books and articles, listening to podcasts and watching educational videos teach them financial literacy, they will learn many other invaluable skills as well. For relatively young kids, here are a few educational YouTube channels to get them started as well as some books for the youngest age group.
As they get older, make the step towards the kind of books that you would read for your own education. If you fear that they might still be too difficult to understand for them, read the book together and let them ask any questions that come up. It’s a great way to teach and to bond at the same time.
And so, that’s my view on the matter.
As a parent it’s up to you to make the decision in what you do, it’s all about your son or daughter after all.
Become a Banker
As a kid there were always a dozen things I wanted.
When you stop buying things outright and giving them an allowance (with or without extra earning opportunities), you may find they come running occasionally (or frequently) asking for more. You’ll hear the pleas and reasoning on why they absolutely NEED the extra cash to buy this “essential” toy or to go somewhere with friends.
Don’t just give them the money!
That beats the entire purpose of teaching your kid about money.
Instead, you can make a deal with them. A deal where you will give them the money, but in return, you will deduct a certain amount from their allowance every week for a certain amount of time. In doing so, you teach them that they cannot do everything and that they need to mind their spending.
But here’s the important part:
You’re going to deduct money with interest!
If they want to borrow $10 for example, then you could cut their allowance by $2.50 for 6 weeks. Personally, I would make sure the total adds up to 1.5x the amount they want to borrow at the least. It’s a great way for them to learn how dangerous borrowing can be for someone’s financial situation. And hopefully, they will get angry or tell you that it’s unfair.
If not, that could be a sign they don’t really understand the numbers. Or it could be that they think the sacrifice is worth it (the present bias at work). Try talking to them to see if they understand the math of the deal you’re offering, and if they do, you can raise your interest rates for the next time.
You want them to feel the pain of borrowing money!
It sounds cruel, but it’s for the best.
When they do protest about it, take them aside to carefully explain how many adults borrow money as well and how it affects them financially. Let them know that by using a credit card or borrowing money later on in life, that they will pay multiple times the amount they put on that card due to interest.
The Power of Saving and MomDad Inc.
Of course, that coin has a flip side as well.
The teaching method above will help your child understand how borrowing and credit cards work, and how they affect someone’s financial situation. It’s an important first financial lesson for any child. However, you want them to understand what else they can do to improve their personal finances.
Firstly, by saving.
This can simply be done through talking to them about it, or by warning them when they want to spend their allowance. Let them know that if they spend their money now, they may not have enough next week when their friends want to go to the amusement park. And thus allowing them to be aware of their spending.
This is where we introduce investing.
If you want to become and stay rich, investing is an absolute must! So you want to teach your child how investing works. But of course, you can’t open up a brokerage account for a small child. So instead, you as parents will be the company they can “invest” in.
Firstly, make a couple of certificates out of paper, cardboard or plastic.
These will be your shares.
Then, you will need to agree on some prices. For example, if their base allowance is $5/week, you could allow them to buy shares in MomDad Inc. for $7.50 each. In return, their weekly allowance is increased by let’s say 25 cents for each share that they hold in their possession. (pick numbers that make sense for you and your child)
This will teach them 2 things:
- You can use this as an opportunity to teach them how the stock market works.
- It allows them to understand cash flow.
Here’s What to Explain to Your Kids About Money and Investing
Let’s talk about both of these lessons.
The first one is pretty straightforward, but you can make it more complicated if they get older.
For the very basics, tell them that investing means that you buy a tiny part of a company (use examples like McDonald’s or Apple, something they are familiar with). Tell them they are a partial owner of the company when they invest. And so, they will get a tiny part of the company’s profit as well. Explain the link of shares in MomDad Inc. and the extra allowance they get.
As they get older:
You can go a bit deeper, by explaining that the prices of stocks can rise or fall, talk about diversification as well as the risk and things like that. It’s a bit too much to go into in this guide, but here’s a video you can watch that will give you at least a basic understanding of the principles of investing.
Moving on to the second lesson:
Cash flow & the difference between assets and liabilities.
Now admittedly, this is where things can get slightly complicated. So the key is to keep it as simple as possible, especially when your children are still young. If they are teens, you can go into more detail obviously, but under the age of 10 especially, keep it stupidly simple!
Just tell them this:
An asset is something that puts money into your pocket every month (flash some of your “stocks”). See these? Whenever you invest in a stock, you get paid a bit of money every month that you don’t have to work for. A liability is something that takes money out of your pocket every month. Remember when you borrowed $xx for Y? Your allowance was lower for a couple of weeks until you paid back that loan. Do you see how that works?An awesome parent
They’ll likely get it, since it’s drilled down so much to just the essence. If not, try taking it step by step and explain things slowly, checking at every step step if they understand it. It’s literally the single most important lesson they will ever learn in their life! So make sure it’s both clear, and repeat this teaching regularly.
Once that’s clear, tell them this 1 simple thing:
“If you want to be rich use your money to buy assets.”
That’s literally it!
If your child is a bit older, you can test them on their understanding by naming a couple of things and asking them whether they are assets or liabilities. Also make sure to have them explain to you why they fall into one category or the other (or can be both depending on how to use it).
Examples of assets:
- Index funds (a small piece of a lot of companies in 1 “package”)
- Real estate (when rented out)
- REITS (Real Estate Investment Trust, basically like a stock but for real estate)
Examples of liabilities:
- Credit card debt
- Your house
- A car
Playing the “Stock” Game With Teens
The 2 methods of teaching kids about money work fantastic for children.
However, with teens, it might be a bit too trivial for them at some point. I would still recommend it as a starting point, but once they grasp the basics, I would recommend taking it a step further. Instead of MomDad Inc. stocks, open up a brokerage account for them, so that they can get real-world experience with investing.
Note: You will most likely need to open it in your own name if your child is underage.
Allow them to make their own decisions about what to invest in, they should learn to make their own decisions since they’ll be close to becoming adults at that stage anyway. However, while you should let them make their own decisions, I would recommend questioning them about those. not so much to doubt their decisions but rather to test their knowledge. If someone can’t explain why the make a certain investment, that would be reason to examine further.
The Truth About Teaching Personal Finance to Children
It’s tough, I’ll tell you!
Personal finance is a complex topic that entire books have been written about, and many more will be written. It would take dozens, if not hundreds of articles or YouTube videos to cover everything there is to know about it. So how do you as a parent teach such a complex topic to your children?
Many people are hesitant to teach their children about money, because for millions of people it is a topic they do not fully understand themselves. If you want to give your children a solid financial education, it doesn’t have to be all that difficult though. If you can teach just these basic lessons to your child, they will have a better understanding of how money works than a lot of people today.
Guide them you should, but faith you must have.
Ultimately, it is their journey and you are just one of their mentors along the way, like Yoda was to Luke. If you can just teach these few lessons and spark their interest in personal finance and investing, you will have done your job as a parent in this regard. They’ll build upon the foundation you laid for them and figure things out!
If there was only be 1 thing you could teach your kid about money, let it be to know the difference between assets and liabilities. If they know that 1 piece of wisdom and act upon it, then they WILL do well financially. They might even support you in your old days.
So, if you’re still reading up until this final moment, please do me one quick favor. Help the next generation in becoming financially literate so that we may reduce poverty and income inequality. Simply share this blog post with any parents that you know, so that they can teach their kids!
They’ll be grateful to you, and so am I!