If like millions of parents across America, you recently rejoiced in the high school graduation achievements of your child, congratulations to you and your child. But as parents, we know our work is never done. Now that these young people are transitioning into adulthood, it’s important to provide them with the personal finance tools that will serve them well into their college years and beyond. That stash of cash your child received as gifts is an excellent teaching tool. Here are six very important lessons parents can impart to their college-bound kid this summer to prep them for the real financial world.
1. Explain how compound interest works and why it’s important to take advantage of it.
Compound interest is a beautiful concept that all young people should take advantage of. The earlier you start saving and investing the more time you’ll have to let your money grow. Compound interest is your Principal (money) x Interest Rate (free money) x Time. The more principle, the higher the interest rate, or the longer the amount of time the more money you’ll end up with. For example, let’s assume that you give your child $1,000 as a graduation gift and they put it in a six month certificate of deposit (CD) at their credit union. Let’s further assume that the CD is earning 10% monthly (because I like to work with round numbers):
In our example using round numbers and simple interest that $1,000 gift earned $758.25 in six months due to compound interest. Imagine if your student left your gift to accrue compound interest for a year. For five years. For ten years. This is the single most critical personal-finance concept that students need to learn.
2. Help your child open a retirement investment mutual fund.
Now that your student understands what compound interest is and how it works, it’s important that they start investing for retirement now. You’ll notice that I didn’t say “save” for retirement, I said “invest.” Saving implies that you are squirreling money away in a savings account at a bank or credit union. Investing implies that you are taking part in the stock market. We have all heard talk about Social Security being shaky and how younger generations will have to work longer and longer. It’s important to help your child prepare for what’s to come. If you have a financial advisor that you work with, set up an appointment for your child to speak with them with you present. If you don’t have anyone that you’re currently working with, you can visit the website for the National Association of Personal Financial Advisors to find a fee-only advisor in your area. Many retirement mutual funds can be opened with no money as long as you have at least $50 electronically transferred to your retirement investment account every month. Anyone with earned income can open an account. Think about how much compound interest can be accrued over the 49 years that an 18-year-old will contribute to a retirement account before they can take Social Security at 67.
3. Make sure they get a job.
After graduation any students want to have a summer of leisure. They want to have fun before they have to start adult life. All of that’s understandable, but think about the life lessons that they will learn from having a job this summer. They’ll learn that life includes work and must be lived. They’ll learn that if they want something they’ll have to work for it. They’ll learn time management skills and have networking opportunities. They’ll get a jump on the competition and save some money in the process.
4. Make sure they have a checking account at a credit union or bank—and that they know how to avoid fees.
If they don’t have a checking account at a credit union or bank this is the perfect time to open one. Help them choose a financial institution that will be easily accessible (credit unions have the most ATMs in the country due to the co-op network and have free ATM access at all 7-Elevens in the country), have low fees (including monthly account fees, overdraft fees, non-sufficient funds fees, etc.) and have great customer service. Guide them through the process of choosing a financial institution, but encourage them to due their homework and make their own decisions.
5. Save in an Emergency Fund.
Are you familiar with Murphy’s Law? It says that anything that can go wrong, will go wrong. That’s why it’s important to teach your child to put away a few dollars (10% of their net income is a great start) in an Emergency Fund as soon as possible and add to it as often as possible. An Emergency Fund can be kept in a savings or a money market fund at a credit union or bank. The key things to remember are that the money should be liquid in case the child needs it, but not too easy to access so it won’t be spent haphazardly.
6. Teach them to delay gratification.
As the amount of money in their retirement and checking accounts grows, your child may be tempted to use the money for things they don’t really need to buy. Since they are adults, you can’t make them do anything, however you can strongly encourage them to leave the money where it is. Joachim de Posada gave a TED Talk where he talked about his experience conducting a longitudinal study, The Marshmallow Experiment, with kids in Columbia. He found that kids that could wait 15 minutes to each the marshmallow in front of them when they were kids ended up with better grades years later. Students that couldn’t wait were more likely to end up with poor grades in later years. If children can learn to delay gratification, they can take advantage of compound interest and build good money habits.
This summer is going to be a turning point for thousands of young people across the country. Make sure that your child uses this summer to start off on the right financial foot.