Basic financial literacy is critical to help teach children and new investors how to properly handle money.
Checking and savings accounts, budgeting, and compound interest are among the key components of financial literacy.
Kids taught financial literacy can avoid bad habits and better handle their finances as adults.
For many adults, their first exposure to financial literacy was a dear old piggy bank, or perhaps a toy cash register that made a “ka-ching” noise as it dispensed play money. Kids grow up fast, of course, and soon they’re out in the real world trying to figure out what to do with real money. As a parent, how will you ensure that, when they begin “adulting,” they do it armed with the best financial advice available?
“Children should be taught financial literacy at an early age to help put them on a path to health, happiness, and prosperity as adults,” said Viraj Desai, senior manager, portfolio construction at TD Ameritrade. “Dropping a few coins into a piggy bank every day is good, but there’s much more to it than that.”
Although parents are role models for their children, “many adults struggle to manage a budget, build up emergency funds, or maintain discipline when it comes to impulse purchases,” Desai added.
Spending money can be therapeutic and a bonding experience with your kids, but it’s important to note that children learn by watching their parents. “Poor financial behavior on the part of parents can often lead to children who grow up with similar habits,” Desai said. New investors also need basics on financial advice, including budgeting and saving, and an understanding of how markets function. Desai pointed to three straightforward, easy-to-learn principles of financial literacy that can apply to both kids and adults.
Principle #1: Delayed Gratification
This principle is about establishing long-term savings and getting familiar with banks and other financial institutions. “By opening a savings account, not only do you start developing a relationship with your local bank, you also build trust in the institution,” Desai said. “A relationship with a bank often leads to financial freedom and independence.”
By becoming comfortable managing a checking account, you gain an entryway into wealth management and other financial services, because there’s already an established base of trust.
Another key component: behavioral impulse control. Everyone has things they want. However, you may not be able to afford everything you want. Spending part of an income or allowance on something for short-term enjoyment is fine, but you’d be wise to save the rest for the long term.
“Inevitably, there will be something down the line you want,” Desai said. “With delayed gratification, you’re establishing financial discipline to save more and more over time as you prioritize purchases that are most meaningful to you.”
While we’re on the subject of impulse, credit cards are another aspect of personal finance and financial literacy where everyone must exercise caution and discipline. There’s nothing wrong with teaching kids how to use a credit card, but they should be aware of the risks—higher interest rates and the potential for huge balances to pile up quickly. Pay off that balance every month.
Principle #2: Goal Planning—Short and Long Term
For kids, this can be a difficult concept to unpack. Maybe a child wants a bike, scooter, or something that could cost a few hundred dollars. Is making a quick trip to your local sporting goods store and buying the thing really the best course of action for a parent? Instead, consider suggesting the child puts, say, $5 or $10 away each week, with the goal to save enough to eventually buy the item. This is the essence of goal planning—an important step on the road to financial security and stability.
As Desai pointed out, this principle transfers into adulthood when you save for big-ticket items such as homes, cars, boats, and vacations.
“Learning how to stagger your goals also applies to retirement planning and to transferring assets to your kids,” Desai said. “Being able to manage more complicated goal planning starts with managing simpler goal planning at a younger age.”
Principle #3: Emotional Maturity and Spending Discipline
A child or young adult may not have the experience or frame of reference to envision the potential for a small amount of savings to gain greater value months or years ahead. They may need some help learning the concept of compound interest or how savings accounts, CDs, bonds, and other similar vehicles work.
“By learning financial literacy earlier, a child can develop emotional maturity and discipline toward money that you can apply through the course of your life,” Desai said.
For new investors, a similar mindset applies: Getting too emotional about a purchase, or an investing decision such as buying or selling a share of stock, is a recipe for trouble. Best to take a step back, collect your thoughts, make careful and thoughtful decisions, and seek advice from an investment professional, if needed.
Case in point: For some adults who receive a large year-end bonus from their employer, there’s often an impulse to blow the money quickly and lavishly. That’s unwise.
“It’s OK to spend part of that bonus,” Desai said. “But put some of it away for a rainy day. Working to manage that impulse from an early age can help greatly later in life.”
Kids and Young Investors: Get Started Now
In other words, invest in yourself. Adults don’t necessarily need a piggy bank on their desk, but consider setting aside an “allowance” every week or month in a savings account or an investment account that you’ve thoroughly researched—meaning you know what kinds of instruments are in it (stocks, bonds, etc.) and you’re comfortable with your potential risks.
Keep meticulous financial records and regularly update a household budget that tracks expenses and income.
For parents, the earlier you get kids started down that financial journey, the further down the road they’ll likely be when it’s time to leave the nest.
“Children are more receptive to learning,” Desai said. “As people get older, they get set in their ways. Once you develop habits, it’s difficult to change. If you develop the right habits from an early age, you’re able to maintain those good habits through your life. It pays dividends if you start earlier.”
Lifelong financial learning