Teach Your Children Well: Financial Strategy for Young Adults
A recent question from one of our clients struck me as excellent inspiration for a blog post of wider appeal. It went something like this:
“My son is now 18 and tells me he wants to invest in stocks, or mutual funds, what do I think, etc. He has $1,700, so not really enough to shake the markets, but I am happy he is developing an interest. Before I respond to him, I wanted to run this by you for thoughts and ideas.”
Helping your child become a financially independent adult is every parent’s dream. And nightmare. Every fiber of your motherly or fatherly being wants to do it for them. You want them to learn from your sage wisdom instead of suffering their own mistakes. But you know you can’t do that. Not forever, anyway. Here are some ideas on how to equip them for their own journey as a grown-up money manager.
Of Horses and Carts
As your young adult children grow increasingly anxious to take charge of their own money, it’s understandable if they want to hurl themselves straight to where the action is at: seeking gainful employment, using a credit card, making their own investments.
All good and necessary steps. But before they’re ready to gallop, the biggest favor you can do is help them pace themselves, tackling first things first by familiarizing themselves with the underlying essentials that lead to financial well-being. Just as you wouldn’t hand over the car keys until your child has learned the rules of the road, he or she is ill-served if given a credit card or a trading account with no understanding of how to safely use them. And these financial vehicles don’t come with air bags for crash protection!
One resource I like is The Mint – tips for teens. Encourage your son or daughter to read through each tab here – earning, saving, spending, owing, tracking, giving, investing, safeguarding – before investing any monies. Each topic represents an essential pillar in the foundation for your child’s lifetime of wise financial management. Another source I like is [email protected] High School, which offers a host of articles and videos created specifically for high school students on topics from business to entrepreneurship to college.
Avoiding a Crash Course in Investing
Some thoughts about investing in particular. (And, by the way, this advice is suitable for investors of all ages.) Most investors still believe that the only way to participate in the market is the way most frequently advocated in the popular press and by Wall Street’s salespeople: Become or hire someone smart enough and/or lucky enough to consistently pick winning stocks and avoid losing ones. Because this is the most common approach to investing, many websites that provide otherwise-sound financial advice to young adults encourage them to try their hand at stock-picking as a “fun” way to get started.
In our opinion, while stock-picking may seem like an entertaining way to introduce market investing, it’s instilling the wrong mindset from the outset. In fact, it’s not a whole lot different than sending them to Las Vegas for their financial education. The biggest risk is that they may actually succeed in picking some winners, and decide that’s a great way to continue investing their life savings. Inappropriate investment habits when they’ve got $1,700 at stake can eventually turn into disastrous outcomes when their portfolios are considerably larger.
If they still can’t help but want to try their hand at choosing a winning stock or few (the allure can be strong), encourage them to do so only with a modest portion of their total savings that they can afford to lose entirely, should an idiosyncratic risk be fully realized.
What do we recommend instead? Just as we counsel all investors, investing should be approached based on individual goals and the decades of peer-reviewed academic evidence on how markets deliver substantive wealth to patient participants. This typically involves investing in diversified, low-cost mutual funds that expose you to the market’s long-term risks and expected rewards.
We know. This is really boring compared to the potential thrills of picking the next Apple or Tesla. But consider this observation from economist and Nobel laureate William Sharpe: “In the long run, this boring approach [passive investing] can give you more time for more interesting activities such as music, art, literature, sports, and so on. And it very well may leave you with more money as well.” (Source: Indexed Investing: A Prosaic Way to Beat the Average Investor)
Additional Sources and Ideas
- Begin With Risk and Reward – As touched on above, it helps to gain an early understanding of the critical relationship between financial risk and reward, so that your child can establish and maintain a healthy balance between the two throughout his or her financial journey. For the investing component, The Mint offers a handy visual.
- Set up the Infrastructure – Sharebuilder.com is one good place to set up an account and make an investment. Fees are low for a young investor with little to invest. My own two boys – excuse me, young men – have accounts here.
- Establish a Roth IRA – We’ve covered in previous posts how beneficial it can be for young adults with earned income to save toward and establish a Roth IRA. They’ll benefit early on from a double dose of benefits. First, they have an enviably long timeline in which to potentially take on added risk to achieve long-term expected rewards for their eventual retirement. Second, they are well-positioned to minimize the debilitating damage done by taxes along the way.
- Let Them Fail – This last one may seem counterintuitive but, to a point, it’s okay to let your child fail at his or her early financial ventures. To cite a time-tested analogy, this spells the difference between teaching your child to fish versus doing it for them. With our preceding caveat about investment strategy in mind, we like this advice from Charles Rotblut, vice president with the American Association of Individual Investors: “Don’t give your teenager carte blanche, but do allow them to fail. … Let them have a sense of ownership by having them explain why they want to own a particular investment and why they think it is good. As long as their explanation sounds somewhat rational, let them buy the investment. If something doesn’t go right, help them understand why.”
As with any life lessons you’re seeking to instill in your children, there’s so much more that could be said and done. But, as Helen Keller has observed, “Security is mostly a superstition … Life is either a daring adventure, or nothing.” At some point, you must let your adult children dare to venture. As you and they proceed, we remain here to help.
Sage Serendipity: Lest you think we’re as disciplined in the rest of our lives as we are in our investment approach, here’s a fun lesson about the value of drawing outside the lines: The Problem With Correct Answers.