Inspired by this post from Mr. Money Mustache, the wife and I sat down to figure out how we could teach our children about money. At ages 7 and 9, we wanted to encourage saving and investing over consumerism and profligate spending. Over a series of sit down discussions with the kids, we were able to cover some basics and develop a starter investment plan for them.
Equity vs. Fixed Income
First, we tried to provide a basic education on stocks vs. bonds using an easy to grasp example:
Kid L opens a lemonade stand in July and needs $6 for lemons, sugar, and cups.
Kid B loans him $3 with a plan to be repaid $4 in 4 months.
Kid S invests $3 with a plan to split the profits equally every month from the business.
The business earns a profit of $1 each month.
In month 1, Kid B is paid $1 and Kid S is paid $0.
In month 2, Kid B is paid $1 and Kid S is paid $0.
In month 3, Kid B is paid $1 and Kid S is paid $0.
In month 4, Kid B is paid $1 and Kid S is paid $0.
In month 5, Kid B is paid $0 and Kid S is paid $0.50.
And so on...
The kids seemed to get that stocks are an ownership share of a real business, while bonds are a loan to that business. They also were able to extrapolate that stocks provide better long-term return on investment.
Reducing Risk Through Diversification
Next we talked about how ice cold lemonade is great in July, but in lower demand in the chilly winter months, when the business might not make a profit or could even lose money. Instead of investing $3 with Kid L and his ice cold lemonade stand, why not invest $1.50 with him and the other $1.50 with kid H who is opening a hot chocolate stand? This illustrated the value of diversification, which they seemed to absorb well.
Those Who Understand Compound Interest Earn It
Finally, we began to discuss the value of compound interest. This was a tough one, so we had to use an online calculator to demonstrate how quickly interest, when reinvested, snowballs into a large sum of money.
At this point, we made our pitch. If they desired they could invest now in the Bank of Mom and Dad. The terms would be 5% interest compounded monthly (I chose a high rate of interest to illustrate the effect of compounding as dramatically as possible). The first of every month was declared compound interest day, when we’d sit down with a spreadsheet and review their deposits and earnings.
They’d accumulated loose change and bills in piggy banks and secret drawers thanks to grandparents and the tooth fairy. Our offer prompted a rush to locate and count up the various coins and bills.
The Life-Changing Magic of Tidying Up
We’ve even used the bank as a decluttering tool. We’re fortunate to have loving family and friends who like to bestow gifts during birthdays and holidays. Their generosity sometimes leaves us with more toys and big plastic crud than we want or need. In response, we created an unopened gift redemption policy: any gift the kids decline to keep will enter our regift stockpile, with the kids getting a deposit in the amount of the Amazon price into their bank account. This policy has been popular, and now that they have real experience with opportunity costs, they tend to be far more selective about which gifts to keep.
Thus far, the Bank of Mom and Dad is a resounding success. They each are making over $20 in interest a month, a number that leaves them wide-eyed with delight. When the occasional penny or nickel is found on a playground, they immediately bring it to me for deposit. When their accounts get to a threshold level, we’ll invest them into a total stock market fund and let them experience investing firsthand.
How did you learn about money? If you have kids, how do you plan to teach them?
Financial Literacy for The Newly Minted Physician