What’s a greater predictor for success in life: a child’s intelligence or their parents’ wealth?
If you guessed the latter, pat yourself on the back. A recent study reported by the Washington Post analyzed the genes associated with gifted intelligence, and compared them with fathers’ incomes to predict college graduation rates. Perhaps surprisingly, fathers’ incomes proved far better correlated with college graduation rates than innate intelligence.
In fact, the most gifted children from poor families had lower graduation rates than the least gifted children from rich families.
Which goes to show that ambition and success are learned at home. Schools don’t teach personal finance or financial literacy, and they certainly don’t teach wealth literacy.
Here’s what your children aren’t learning in school about money – and what you should teach them yourself to help them succeed.
1. Key Personal Financial Metrics
There’s an old saying in business: That which gets measured gets done.
In your personal finances, there are several key metrics to track regularly, including net worth, active income, passive income (more on this shortly), emergency fund, and savings rate. Every adult should have a strong sense of these numbers without having to look them up.
Teach your children how to calculate their net worth, and show them how to track it using automated tools like Mint.com. If you don’t show them these numbers, who will?
2. How to Create a Budget
The only thing most people like less than creating a budget is sticking to one, month-in and month-out.
But the skill of budgeting is the difference between hitting the ground running in your early 20s, staying debt-free and saving money early, and spending the first ten years of adulthood swimming in debt and desperately trying to figure out how to escape it.
Parents do their children a disservice by paying them an allowance without forcing them to budget. In the real world, they’ll have expenses. Charge your kids rent, charge them a (tiny) percentage of groceries, utility bills, and their clothing costs. Raise their allowance accordingly if need be.
And don’t just take these expenses out of their allowance. Make them actually pay you – they need to get in the habit of paying expenses and learning how to budget. Build in consequences if they fail to pay for an expense, such as a 50% penalty if you have to deduct it from their next allowance payment.
Most of all, teach them to set a target savings rate first, and to set aside their savings as the first “expense” paid when they receive their allowance payment.
Speaking of their allowance payment, schedule it to direct deposit into their checking account every two weeks, just like a normal paycheck. This will get them into the habit of thinking about money abstractly, rather than as physical cash.
3. How to Create (and Measure) Passive Income
Passive income is the key to reaching financial independence and retiring. As Warren Buffett is fond of saying, “If you don’t find a way to make money while you sleep, you will work until you die.”
Teach your kids about the various investments that generate passive income. Explain how dividends from stocks work, how rental real estate works, bonds, private notes, crowdfunding websites, peer-to-peer loans, and so on.
To illustrate this point, invest jointly with them in a high-dividend ETF or a rental property or a debt service of some kind. Make them invest their own money alongside you, as a junior partner.
Then make sure they get their portion of the revenue coming in every month – money they didn’t have to lift a finger to earn.
4. How to Invest in Stocks
Stocks intimidate most people. In fact, younger Americans’ fear of stocks is getting worse, not better.
A 2018 poll by Gallup found that before the Great Recession, 52% of Americans under 35 owned stocks. But by 2018, that number had dropped to a troubling 37%.
That’s worrying because stocks have far greater growth potential than bonds or real estate. Young people in particular should be taking advantage of high-volatility, high-return stocks to compound and grow over the next few decades, to fund their retirement.
Don’t let your children fall into the same trap. Teach them what a price-earnings ratio is, what annual yield from dividends is. Create a brokerage account with them, and then create a Roth IRA with them, and explain the tax advantages behind it.
If you (and they) are inclined, research and pick stocks together. Or if that’s not your style, simply choose a few low-cost index funds and explain the concept of market capitalization, and why they should invest money in both large-cap and small-cap funds.
5. How Much to Save for Retirement
Financial independence and retirement are the ultimate financial goal in life.
Everyone needs to have a sense for their own nest egg target amount, and a target date for reaching it. Sure, it seems awfully far away when you’re young. But that’s precisely why little more than a third of adults under 35 have any money invested in stocks, when they should be well underway.
And don’t count on Social Security to cover your kids’ retirement costs. Benefits have been shrinking since 2000, even as more retirees lean on Social Security as their primary source of income.
Explain the concept of safe withdrawal rates to your kids. While you’re at it, brush up on your own retirement calculations. Sit down with your kids and show them how to run retirement and investment numbers for themselves, using our Choosing Wealth calculator.
With it, you and they can calculate exactly how much you need to save every month, in order to reach your target nest egg amount by your target date.
6. How to Manage Debt as a Tool
Most people don’t understand how to manage debt properly.
Some lean on debt like a crutch, spending more than they can afford, while others refuse to get anywhere near debt. But the truth is that debt is a tool, like a large kitchen knife. It can be used constructively, or it can be wildly dangerous, depending on the user’s skill.
For example, credit cards can generate rewards, and can serve as an extra safety net in times of true financial emergency. Or they can cost extraordinarily high interest, for bearers who fail to pay them off in full every month.
Likewise, debt can be used to buy an income-producing rental property, that generates an extra $200/month in income for you. Or debt can be used to finance a home far more expensive than you can afford.
Teach your children to wield debt skillfully as a tool. It’s useful, but it’s also dangerous in unschooled hands.
My parents didn’t teach me much about money growing up. In nearly every other way, they were excellent parents. But they were tight-lipped about money, and as a result I spent the first decade of my adult life having to painstakingly learn personal finance on my own.
It was a lost decade, and I’m still playing catch-up on my retirement investing to this day. And I’m one of the lucky ones, as someone who developed an interest and later a passion for personal finance and investing.
Teach your kids about money, because no one else will. Or worse, they’ll learn from whoever is willing to talk to them about money – even if that person knows little about it themselves.
Give your kids a head start on the road to riches. They’ll thank you for it later, even if they roll their eyes at you today.