10 Investing Lessons You Must Teach Your Kids

By Damian Davila on 20 March 2015 11 comments

Roughly 68% of Americans feel that saving for retirement is harder than they anticipated. Some 25% of all middle-class Americans "get depressed" when even thinking about it. And 40% of millennials have no idea how much money to save. The most frightening statistic: 21% of Americans think that winning the lottery is the most practical way for them to fund their retirement.

I discussed these problems and the financial behavior of investors with Rob Pivnick, a financial literacy advocate and author of "What All Kids (and Adults Too) Should Know About...Saving & Investing." His message is that parents should teach their children the right habits as early as possible, so they don't become one of these statistics. And it doesn't have to be difficult. Here are 10 easy ways to teach your children about smart investing.

1. Start Them Off Early

Starting to save as early as possible is the easiest way to let your money work for you. In fact, this is probably the number one thing you can teach your children about money.

Consider this example from Rob's book comparing two savers: One starts saving when he is 20 years old, while the other waits until she is 30 years old. Each one saves $100 per month until they are 60 years old, and they both get the same 8.5% return. The early saver will have $406,825. The saver who waited ten years will only accumulate $166,339. That 10 year difference results in over $240,000 more growth! But the difference in the amount contributed was only $12,000 — compound interest made up all the rest. So, encourage your children to start investing now.

2. Don't Try to Beat the Market

Your kids should want to be average — at least when it comes to investing. It is better to embrace the market than try to beat the market. It isn't very often in life that you won't tell your children to try to be the best, but when it comes to investing, teach them to be average. Passive management, or indexing, is an investment approach that tries to match the performance of the market as closely as possible rather than try to beat it.

Over the long term, it is impossible to consistently beat the market without taking on additional risk. Over just about any historical five year period, passive index funds beat actively managed funds. Over the last five years, for example, only 20% to 35% of actively managed funds beat the benchmark for their category. The professionals aren't smarter than the market. And neither are you (or your kids). It's a humbling fact, but still a fact nonetheless. (See also: 5 Investors With Better Returns Than Warren Buffett)

3. Minimize Expenses: Invest in Low-Cost Index Funds

Actively managed funds have an average expense ratio of a full percentage point higher than passive funds. One percent may not sound like much, but over the long term it becomes much more significant. How does this translate into lost dollars? Well, from another example in Rob's book, if you invested $100,000 over 30 years at an average yearly growth of 8.5%, paying for those higher fees would cost you approximately $280,000. (See also: 3 Steps to Getting Started With Index Funds)

Everyone should know that past performance is no indication of future returns. But does everyone know that the most accurate predictor of future returns is low fees? When looking at factors like past performance, fees, and Morningstar ratings, expense ratios are the only reliable predictor of future performance.

4. Think Long Term: Buy and Hold Is the Best Strategy

The average investor's annual return is around 4%. That's compared to the historical average market return of 8.5%. Why? Because we tend to invest emotionally — which causes us to buy high, and sell low (instead of the opposite).

Emotional investing is a losing strategy. Don't fall into this trap — teach your children to stick to their long term plan and ignore the daily market swings.

5. Don't Put All Your Eggs in One Basket

An important part of smart investing is diversifying. While diversification alone won't increase returns, it allows investors to reduce their risk. Diversification limits losses without sacrificing gains. It's the only way to do that. It's the "free lunch" of investing.

By spreading investments over a variety of sectors and assets, the risk that any specific investment will fail is partially canceled by the other investments, thereby lowering the overall risk. Teach your adolescent children to diversify among asset classes, and furthermore, to diversify within each type of asset (such as different sectors, geographical regions, market capitalization, industries, etc.). Pivnick's book devotes a very readable chapter to diversification and provides useful examples of how to make it work for you.

6. Involve Your Children in Investment Decisions

Parents know that children tend to model their behavior after them, so it should be unsurprising that children's saving and investing behavior also follows that of their parents. Any chance you have to involve your children in day-to-day discussions about money are learning opportunities. And they are habit forming. If your children see you making sound, reasoned decisions about spending, they will start to think the same way about their spending habits.

7. Have Kids Write Goals and Savings Charts

It shouldn't come as a surprise that those who write down their goals are a third more likely to reach them. Plus, this can serve as a teaching moment for budgeting.

As soon as your children receive birthday money, are old enough to do chores, or begin earning allowance, start a savings chart outlining their budget. People who write down their savings goals save, on average, over two times more than those that don't write a goal down.

8. Practice Learning by Doing

Anything you can do that actually involves your children in "money" tasks is a teaching opportunity and can instill good spending habits. Here are a few examples Rob provided:

  • Have them help you figure out the restaurant bill and tip.
  • Take them to the bank with their piggy bank to deposit funds in a savings account.
  • Encourage them to take the lead on a refund or return with customer service.
  • Allow them to negotiate a discount on the purchase of goods and services.

9. Give Limited Control and Let Them Make Mistakes

Once they are old enough, young adults should be given limited access to their money or bank accounts. Limited, in the context of parents-get-final-say-and-approve-silly-purchases, but still providing enough room to allow them to make those silly purchases. It only takes one super wasteful purchase to teach a lesson.

10. Teach Rules of Thumbs and Takeaways

Studies have shown that rule-of-thumb money rules affect financial behavior more than a thorough lesson on the topic. So, the rules of thumb must be included in your discussions. Here are some examples.

  • After a lesson on compounding, provide an actionable takeaway, such as "start early."
  • Show the power of diversification with a rule of thumb: "A single stock is riskier than a stock mutual fund."

In Pivnick's book, you can find a great list of 14 takeaways to share with your children. After all, as parents, you want your kids to succeed — so set them up for that success by following these tips.

What are you doing to teach your children about smart investing?

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Guest's picture
Jordan

Great post here! It's so important to teach kids early the value of money and what needs to be done to keep it and grow. Thanks so much for these tips!

Damian Davila's picture

You're very welcome Jordan. Which tip is your favorite?

Guest's picture
Guest

Great article. And the book looks awesome too. thank you.

Damian Davila's picture

Thank you Guest. Check out the book from Rob, it is quite insightful and provides useful rules of thumb & takeaways for children.

Guest's picture
Guest

Good Stuff :)

Guest's picture
Guest

I was not expecting a lot. Pleasantly surprised. Great Article.

Damian Davila's picture

Glad to have you pleasantly surprised, Guest! Let us know if you have any questions on effective techniques to teach kids about investing.

Guest's picture
Guest

One thing that I teach is that investing involves more than the "market". For example, real estate is still a decent investment in some areas, where a 15% annual return is possible. Another is to invest in what you understand, and stay away from things that you don't. Peter Lynch always said this, and it's true. Lastly, to understand the difference between the cost of something vs the value of it.

Damian Davila's picture

That's a good point, Guest. It's a good idea to have a diversified portfolio of investments. As long as you don't put all your eggs in one basket and you're comfortable with the risk involved, real estate may be part of a well-diversified portfolio.

Guest's picture
John55

What???
"Each one saves $100 per month until they are 60 years old, and they both get the same 8.5% return."
What bank pays 8.5% for a savings account?

Guest's picture
David P.

I think he's talking about saving in stocks. According to the Credit Suisse Global Investment Yearbook, stock markets in the developed world delivered an annualized return of 8.5% over the last 112 years.