Parents want the best for their children. They work hard to provide a safe and loving home for them as well as a good education that will set the children on the path to becoming healthy, happy, and independent adults.
Most schools do not really teach children personal finance skills. Therefore, many adults learn about the importance of money management later in life, usually by trial and error.
However, family members can take a few simple steps to empower the next generation, by showing them the importance of saving and investing from early on. Let me illustrate how parents could start their kids on the way to a financially secure life with several simple yet sound habits and concepts.
Importance of financial literacy
Financial literacy is about learning to budget, save, invest and generally make informed financial decisions. Children are familiar with the role of money in our lives. You could also encourage them to appreciate the importance of maintaining a budget — one of the most fundamental aspects of staying on top of their finances in later years.
For example, parents could talk to their kids during the weekly family grocery trips or encourage them to make their own financial decisions with pocket money or savings. It might not sink in first time, but the message should eventually get through. There are numerous user-friendly websites or smartphone apps that adults and kids can use to discuss spending habits or create budgets.
The miracle of compound interest
While your kids might still be too young to appreciate complicated investment concepts, it is never too early to start talking about the importance of interest rates and the power of compounding. Compound interest has a snowball effect on personal savings. As time goes on, interest leads to more money, over and over again.
For example, you can introduce children to the Rule of 72, which would help them calculate how quickly an investment doubles with the impact of compounding. They’d simply take the number 72 and divide it by the percent annual return.
Let’s say an investment is expected to return 10% a year. So, 72/10 = 7.2. Or it would take about seven years for the investment to double.
Time is on the side of the young
The concepts of compound interest and time go hand in hand. An investment needs time to grow and when given enough time, even modest savings add up to substantial amounts.
Let us assume you have a 16-year-old, would like to invest £200 in a fund now with additional £2,000 contributions annually at the end of each year. The time horizon is 50 years. The annual return is 8%, compounded once a year. At the end of 50 years, the total amount saved becomes £1.248m. If the annual return increases to 9%, the amount becomes £1.791m.
Teach kids and young adults that the more regularly they invest and the longer they keep it invested, the faster they will reach their financial targets and can start doing the fun things.
Junior ISAs
Finally for UK investors, a Junior ISA, which is available to those under the age of 18, could be a good starting point to kick-off someone’s saving as income and capital gains are tax-free. My Motley Fool colleagues regularly write about funds and stocks to consider for ISAs, so get your kids reading too if they’re so inclined.