how to talk to your teenager about personal finance

If you have children or younger relatives – particularly teenagers – then this thought probably crossed your mind at one point: “if only they would do some of the things I wish I had done!” Maybe you always dreamed of visiting Mongolia or taking a year off after high school to backpack around Europe. Perhaps you hope your teenaged children will take the leaps you never took. The most important thing you can do is to give them the basic skills to succeed in life. One of the best ways to do this is to teach the teenagers in your life how to invest.

Just as saving is a good subject for children to learn, investing is a great skill for teenagers. Sadly, investing is still not taught in most secondary schools, and many parents who are struggling to get out of debt may not have the background themselves to educate their children. Parents may be embarrassed to admit a lack of skills in this area, but just like “the talk” about sex or drugs, that embarrassment must be overcome for the teenager’s sake!

So what can you do? A few simple steps can be taken. None of them require a huge investment of time.

1. Open a custodial account. A custodial account is opened in the name of an adult “for the benefit of” a minor as a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), depending on your state of residence. Taxes are not collected until the teenager has more than $850 in income, at which point it’s taxed at the child’s rate. Above $1700 it’s taxed at the parents’ rate (these are 2007 limits). However, consider that in order for your investment to generate $850 in income at an 11% rate of return the amount invested would need to be greater than $7700.
2. Put some dollars in it. The amount is not particularly important. If you have the resources to give your child a lot of money to invest, do it. If you don’t have the resources, don’t worry – the purpose is to educate at an early age. Once they have their own money, they can invest it themselves. Your role is to start the fire, not to bring the logs.
3. Contribute a certain amount in lieu of gifts. So much angst is created in our consumer-driven society by a corporate-imposed mandate to buy love through “stuff.” Your child is going to whine when you don’t buy them an Xbox and instead give them $300 to invest. Your job as a parent is to show them, both in word and action, that until they make their own money, it is your money to spend as you see fit. Toys will be forgotten.
4. Sit down and explain the basics. You may not understand the basics of investing. Study. Read blogs, read some of the basic books on investing. You don’t need to understand option puts. You need to understand what a share is, why dividends are paid, what unrealized and realized gains and losses are. If you don’t understand these terms, study.
5. Don’t just buy a “how to” book, though. If you buy a cookbook and follow its directions point-for-point, you can probably bake a cake. Teachers don’t just stand in front of a classroom reading directions from a textbook point-for-point, though, and great chefs do not rush back and forth to check whether to add flour or bacon grease to a chocolate cake. They understand their subject well enough to teach it themselves, not just by reading a book aloud. Do the same with investing – read about investing, not “how to” invest. Sit down with them. Make sure you read the books at the same time as they do. Work through the book with them – make it a question-and-answer exercise.
6. Choose investments together; involve them. To illustrate this point, Bubelah and I made the mistake of steering her younger sister away from a “trendy” stock (AAPL) in favor of a “solid” one (INTL). Even though our reasoning was sound, the decision to buy a particular stock has to be the teenagers, not yours, or they will lose interest in investing. If you make the choices, it becomes another adult-driven enterprise that they have no “real” say in. If they want to invest in speculative risky investments that fail, let them! Losing money can be as much of a lesson as making money. Teenagers are young; they have time to recover from their losses.
7. Go over it every month or quarter or year to review what went right and wrong. Make sure you sit down and look at “what ifs.” What if that dividend had been reinvested? What if the money had been put in a CD instead of stocks? Maybe it would have been better, maybe it would have been worse. Make sure they understand the parts that went wrong – it may be even more important than understanding what went right.
8. If your teen makes some money, ask them to reinvest at least 10% of it, even it’s a single dollar. My own prejudice has always been that reinvesting is key to building wealth. Dividends and gains are not money for spending – not ever. Teach your teenager that just because they’ve received a dividend is no reason to spend it on “stuff.” Learn how to reinvest before ever even touching the money by using DRIPs (dividend reinvesting plans).
9. Teach them not to touch principal. I find the concept of a house’s foundation is useful. Before you can build a castle, you have to lay down a foundation. You can’t pull chunks out of the foundation just because you’re running short of concrete to build a tower. The base of an investment portfolio has to be thought of always and forever as untouchable.
10. Consider alternative ways of investing. Most of the examples I’ve given are equities, because that’s a low-barrier entry into investing. You can invest small amounts easily in the market. That doesn’t mean your teenager can’t learn about investing in real estate or businesses. The same lessons can come from successes and failures in those areas. If your teenager is more interested in building an online business with their investing money, let them. Help them decide, let them succeed or fail on their own, and help them review the results. Despite what the conventional wisdom of the retirement-planning industry may say, you can invest without putting money in the market.

Keep your teenagers engaged and interested, and you may even get excited about investing all over again. Remember that spending and saving habits are established in your early life. Small actions now can stoke the fire of determination to achieve financial success for a lifetime. You can provide the spark.

(Photo credit: kamshots)