It’s that time of year when parents are sending off their children to college. Most high schools do not teach classes on personal finance so here are the top three money lessons I recommend parents teach their college-aged children.
The importance of working part-time while attending college or during the summer cannot be overstated. While some children need to work to help pay for college, others earn money to spend on non-educational expenses. One important lesson you can teach your children is for them to save a portion of their earnings and invest it.
For college students I often recommend a Roth individual retirement account (IRA) as the saving and investing vehicle of choice. Unlike a traditional IRA or 401(k), money is not taxed when withdrawn in retirement. Also, the contributions (not the earnings) in most cases can be withdrawn at any time for any reason without having to pay penalties. Roth IRAs are easy to open and most online brokerage firms offer a wide range of low-cost investment options. For example, TD Ameritrade offers over 300 commission-free exchange-traded funds (ETF) and free education for the new investor.
Assume your 18-year-old daughter works part-time year-round. If she were to save just $100 every month from her earnings and deposit the money each month in a Roth IRA, if she invested in a stock mutual fund or ETF that earned an 8% annual return, by the time she retired at age 68 that money would have grown to nearly $800,000 tax-free. If, however, she didn’t start contributing $100 per month until ten years later at age 28, her money would only grow to $350,000. So starting to invest as soon as possible really makes a difference.
We cannot predict if and when tax laws will change. The government could make it easier or more difficult to save for retirement. That’s why I suggest young adults take advantage of the Roth IRA now if they don’t make too much income to qualify.
An added benefit of the Roth IRA is that although there are exceptions, generally first-time homebuyers can withdraw up to $10,000 from their Roth IRA to help with a down payment.
Young adults face numerous expenses. Why should credit card interest payments be another one? You can save your children lots of money over the years by teaching them to pay their credit card balance off in full each month. New credit card users often think they need only make the minimum payment stated on their bill. Don’t let your kids be fooled!
The author of this article presents a good example. If your daughter were to have a credit card that charges 15% annual interest (which is a lot lower than many credit cards) and she carried an average balance of $5,000, she would pay approximately $750 in interest charges over a year. Depending on how the interest compounds, that’s roughly equivalent to $62.50 per month.
How about this? Instead of paying $62.50 in interest charges each month, if your 18-year-old daughter were to pay off her balance in full each month and deposit $62.50 (that would otherwise have been paid to the credit card company) in a Roth IRA and invested in a fund that returned just 5% a year, when she retired at age 68 she would have a pot of money worth over $160,000.
Whatever your daughter doesn’t pay to the credit card company she can pay to herself!
Despite the dangers of using credit cards, they are a great way to track monthly spending. Teach your children that before they pay their bill each month they should examine every charge on their monthly statement to make sure everything looks correct.
Most credit card companies provide an annual report of all spending by category. It’s a great way to find out how much one spends on restaurants, gas, entertainment, clothes, and other living expenses each year. Once a year I look at my annual spending report and think about what gave me pleasure and meaning over the past year and what spending was simply throwing money down the toilet.
While these three financial lessons are important for children to learn, no doubt they are also useful for parents.
Disclosure: The investment projections are for illustrative purposes, only, and performance outcomes are not guaranteed.
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