From pocket change to a Roth IRA - How I have introduced my child to basic financial concepts
Below is a stream of consciousness without any thought to cohesiveness or direction. Read at your own risk.
I recently had a neighbor ask me how I approached sharing financials concepts with my child. While his kids are a bit younger than mine, we are both in the same situation; clawed our way to upper middle class, first generation of our family to begin to grasp how to get ahead financially, and anything we have learned has was most definitely not passed down to us through the family tree. As I was putting together my thoughts I decided that perhaps someone else would be able to find something in our ongoing journey that adds to their thinking.
My parents taught me a great many things and I am very thankful for them. That said, I didn't get much of a financial education along the way. I didn't have anything figured out in a financial sense until I was at least in my 30's and I do not want that for my son, who is now 12. I have been *gently* introducing financial concepts to him since he was 4 or so. More often than not his own curiosity has led him to ask questions which have given me the opening to share my perspective without being pushy/preachy.
Getting Started:
Our first exercise entailed me laying out my pocket change on the kitchen table each evening. If my son could identify any of the coins (penny, nickel, etc.) he could put them in his piggy bank. Some days he didn't want to play this game, so I just put the change in a jar for future sessions. Periodically my wife or I would take him to a store so he could buy something with his stash; mostly matchbox cars and the like.
I was hoping to teach him that:
· Money has some value and products have a price for purchase.
· Sometimes we may have enough money on hand and sometimes we may have to save more money to purchase something we want.
I think these objectives were accomplished as he decided to occasionally save his coins until he could buy a larger item.
I was pleasantly surprised one day when he asked how we get money. I gave him a basic explanation of an exchange of money for my time/effort to accomplish things for my employer. My employer would then sell to customers. The customer had something available to purchase, the employer made some money and so did I. This seemed to do the trick.
Over the months we progressed. Next, to get the coins he had to know what they were worth, Penny=$.01, Nickel = $.05, etc. For our third step we graduated to the concept of which coin was worth more ... Penny < Nickel < Dime, etc. To sort of finish this stage off he then had to know if 4 Pennies were worth more or less than a Nickel. My son had not yet been to kindergarten and here he was performing entry level math.
A strong foundation: Interest and putting your money to work
Around 6 or 7, I suggested we open up a savings account for him at the nearby credit union. They offer elevated interest for the first $500 in a savings account. He was unsure of this ... why would I give someone else my money? I gave him a short explanation of how the bank would pay him interest on his deposit. They could then loan his deposit to others at a higher interest rate to allow people to buy cars, build houses, or start/expand their businesses such as the new ice cream store in town. His deposit would help the community while allowing the bank, and him, to earn money. Once he understood he could withdraw funds on-demand, he was ready to roll. We opened his account and matched 50% of his deposit to encourage a good start. For the first year we matched all additional deposits to encourage savings with the matching percentage dropping each year as he came into a bit more money each year from birthdays, etc. I requested paper statements for his account and did a brief review when they arrived. He was very delighted that he was able to earn money (interest) for doing nothing!
Other people like your money too
One day my son saw an advertisement on TV for some sort of toy. He decided he had to have it. I let him know that I would be happy to take him to the bank, let him withdraw some of his savings, and drive him to the store for purchase. However, could I offer an opinion? The advertisement makes this toy seem very neat. Advertising is simply a company trying to influence you to trade your money for their product; so they try to make it look as neat as possible. I suspect this particular toy will not be as exciting as the commercial presents. After a bit of conversation he still wanted to purchase the toy, so we did. As I suspected, the toy was underwhelming. This was a pretty inexpensive lesson to learn and he definitely remembers as he continues to make his purchases with care.
The "Aha!" Moment
Following his 8th birthday he deposited a decent chunk of funds (and match) into his account. I let a few months go by and accumulated the paper statements. After a good round of catch we settled on the back deck; him with a lemonade and myself sipping a cold one while we discussed the events of the day. I mentioned that I had noticed something interesting in his last few bank statements and wanted to show him. He quickly recognized that his interest payments have been incrementally increasing over time even though he hadn't had any additional deposits. I asked him if he could think of a reason that might be. (I had asked this question awhile back but he was not interested in deep thought that day so we let it slide for a better opportunity.) Today he was ready and there he sat, deep in thought ... 10 seconds passed, 20 seconds, 30 ... over a minute and nothing but a furrowed brow. I was beginning to think I had fried his brain; he hadn't been quit for a 60 second stretch since the day he was born! All of the sudden his eyes got wide and he nearly leapt out of his chair blurting out, "Dad, do I get interest on my interest?" Yes son, yes you do. That is the powerful force that is compounding interest; interest on your interest. Eight dang years old and an appreciation for compound interest! That was a good day for both father and son!
Generosity and Gratitude
I have a donation account that I feed from my bi-weekly paychecks. We use this to ensure we always have funds available through the year for walks/runs/rides for Cancer, Diabetes, MS, etc. Each year before Thanksgiving we take 1/2 of the balance of the account and pick 3 local charities to donate to. At about 8 or 9 I started to include him in our donation decisions. He picks one, my wife picks one, and I pick one. We then go deliver the checks personally so he can then see how his/our donations might be used. Before Christmas we take the remaining account balance and give 1/3 share donations at that time with each of us choosing who will receive our donation. I think we all 3 get something out of his participation and I wish I had started this one even earlier. Nonetheless, I believe this helps reinforce gratitude for what we have and an understanding to help those in need where we can.
A lifetime of learning/Opportunities
We have tried to reinforce the notion of a lifetime of learning. I have a Master's degree and a PMP certification. My wife recently completed her Master's degree and is considering the pursuit of a PHD. Both our advanced degrees were paid for by our employers. This has led to a few quick discussions of why the company would be interested (we are more knowledgeable, versatile, and valuable) and why we would be interested (increased skills can lead to increased earnings potential, opportunities, career advancement, etc.). Now that he is a pre-teen, one of our reoccurring dinner conversations is, "Did anyone learn anything today?" While these are often silly and inconsequential stories about our day ... I will occasionally look to reference something of substance I mentioned in previous conversations to reinforce that learning something paid off in some way. We will occasionally discuss opportunities in the same manner. (I volunteered for this at work, learned this, and now I have been asked to lead this - result is increased value to employer - occasionally I'll get a small bonus for this stuff and we'll take a portion of it and do something fun with it.) I have likened knowledge, skill, and opportunities to Lego blocks. The more you have and the greater variety you accumulate, the more you can build.
Another way to put money to work:
I bought my first stock/mutual fund when I was 27. I was looking for a way to introduce my son to investing and decided I'd like to use a DGI stock to do so as it mirrored the bank/interest theme he had grasped. For his 9th birthday I bought him one framed share of HAS for ~$33.50 (July 2012). (The framed certificate, etc. was $71.34 delivered - a dubious financial investment!) It just worked out nicely that he enjoyed the Monopoly game and I considered HAS a solid DGI stock with a picture of Uncle Pennybags on the stock certificate. HAS had just raised their dividend 20% and it was yielding over 4% at the time. I figured this would be enough to facilitate some interest from him when he got his first dividend check. I set his first dividend check to come to house. I called ahead at the credit union and asked if they would let a 9 year old sign the back of the check and cash it. Surprisingly, they allowed him to do so (I may have had to sign it as well, can't recall that part). I felt like this would make it real to him and it seems to have worked.
This touched off a firestorm of questions.
· Why did they pay me? - You are part owner of the business; they are sharing the earnings with you.
· Will they do it again? - Periodically they will look at their earnings and decide how much to share.
· How often? - For many stocks, every 3 months or so.
· Other stocks do this too? - Yes, GIS (cereal), VZ (cellphones), TGT (household), etc.
· Can I get more? - Yes you can.
Over the course of the next 3 years he added to his HAS (4.4 shares) holdings and added INTC (1.07) and KO (4.7). HAS grew it's dividend from $.36 to $.51 a share, news that I happily shared with him and he happily received. Towards the end of last fall a few neighbors asked if he would mow their lawns while they were on vacation, paying him $15/yard to do so. He used some of those funds to add to his "portfolio". He was amazed to discover he would receive more in yearly dividends ($16) than he would for mowing a lawn ($15). This has led to the discussion that if you can replace your job income with investment income you can retire. :) Additionally, he joyfully recognizes that $.29 of the anticipated $16 comes from dividends on reinvested dividends (compounding!). We have had the occasional discussion about how the price for a stock is determined, that dividends are not guaranteed, and that he could lose some or all of his money as a part owner of a business. (The last one is a harsh reality that I wove in when he noticed one of our local businesses was no longer open.)
What's next?
So far my son has shown an interest in each of the steps ... why stop now? So here he sits at 12 1/2 (never forget the 1/2). One of our neighbors asked him to mow all summer for them, a few have asked him to cover for them during their vacations, and he decided to umpire for coach pitch baseball ($11/game, approx 1.5 hours). A back of the napkin calculation revealed that he could earn $500 or more this summer. We have already had discussions about how we trade our time (and labor) for money. (It is ok to let someone know you are not available.)
His saving account won't pay him much for the additional deposits and I am not too keen on continuing with his current "brokerage" as they have fees for dividend reinvestment and each individual stock has its own account.
What to do ... it appears that if we document his income then perhaps I can open a custodial Roth IRA for him. I mentioned it to him and we had a discussion as to the pros/cons. considering he will likely continue to earn additional income each year through high school this seems to be worth considering. I am not a lawyer or a financial advisor ... but here is what I think I understand:
Pros:
· You can invest after tax dollars that grow tax free (he doesn't make enough to pay tax!)
· You can invest in pretty much any company
· There is no fee to reinvested dividends
· You can withdraw your original contributions (but not any capital gains) out of your Roth IRA without having to pay tax or penalties, even if the five-year period hasn't passed.
· All funds in an IRA are accessible in an emergency situation (taxes and penalties apply)
· If the earnings have been in the Roth IRA for at least five years he may withdraw them tax-free and penalty-free in certain instances, such as to pay for a first home.
· The first step in contributing to an IRA is opening an IRA - with this step accomplished I think it will be easier for him to begin and continue to fund it.
Cons:
· Buy/Sell commissions are higher than current
· If you need the money in the next 5 years (unlikely) there will be penalties to get it.
· Withdrawals of non-qualified earnings will result in a taxable event
My intent is to use the Roth as a learning tool for him for the next few years. We have been funding a 529 plan to help support College if he is so inclined. I don't anticipate a need for him to dip into any funds he might invest in his Roth. Hopefully this is waiting post-college-graduation for him and he can either keep rolling with it or consider using it for a down payment on a house.
We have been documenting his earned income this year (2016) and I believe I will open his account soon. At best he will likely have $200-$250 he would be willing to contribute, though he could pull from his savings account to supplement if he is interested. I have contemplated a matching program in which I give him some percentage of spending cash or every dollar he funds his Roth. Instead, I think I will see how interested he is in funding on his own to start.
My thought is to make a single purchase towards the fall of the year in A DGI stalwart. $7.50 on $250 is 3% so it will take a year of dividends or so to break even and I will likely have to select a stock partially on how well $250 divides into its share price.