by Michael Osakwe
Having a solid grasp of money and credit is necessary for any responsible and financially-literate person. Unfortunately, though, it’s one of the least taught aspects of life for children and adolescents, and as a consequence, many young adults must learn about money and credit the hard way. Last year, we discovered that 37% of millennials have credit scores that fall under 700, and an additional 39% don’t know their scores at all.
If you have a child, there are likely some personal finance lessons you want to teach them. While this seems like a daunting task, it’s still an important one. I’d like to provide advice that could aid you and offer a starting point for having conversations around personal finance with your child. Continue reading as we detail four personal finance lessons you can teach your child now to help them become a financially-literate adult.
The value of money
As a financial advisor, I am well versed in the most common pitfalls parents and guardians fall into when teaching children personal finance. Giving your child an allowance is an excellent start to teaching them about money, because it helps illustrate the idea of income, but the personal finance lessons shouldn’t stop there. Gaining a familiarity with money in general is essential to building your child’s understanding of personal finance. This means you should help your child understand that they can’t always just collect money and that sometimes they will have to spend money when they least expect it, like if an emergency pops up. If you’re looking for inspiration as to how you can implement this concept (besides providing an allowance), you may want to check out the FDIC’s free Money Smart for Young People series, which provides exercises, resources and discussion topics for children of various age groups.
Borrowing isn’t always a bad thing
A common mistake that a lot of parents make when teaching personal finance lessons to their children is a general failure to mention the role borrowing can play in building both good credit and a healthy financial life. Worse yet, some teach that avoiding debt entirely is a smart financial move, which isn’t true, given that you need debt (even if it’s temporary debt) to build credit and sometimes wealth. While being in debt is not necessarily fun or good, taking out loans or using a credit card are not behaviors to be feared. A survey we conducted last year, for example, indicated that only 23% of millennials are using their credit cards for everyday purchases, which means that many are missing out on a great opportunity to build their credit (with responsible use of the card) and even earn rewards on their purchases. As such, it’s wise to teach your child that as long as they are borrowing for the right reasons, they’re responsible with the borrowed money and they have a plan to pay back the money they borrowed, they will be fine. One way you can do this is to purchase something for your child, like a toy, then work with them to pay off the owed amount over time — allowing them to see how borrowing works. If your child is old enough, you may want to consider charging them interest (for example, $0.25 for every late payment), so they can learn that when they miss a payment, there are consequences. When your child gets a bit older, you can teach them about the various types of borrowing by distinguishing between loans and credit-based lending like credit cards.
Credit reports and scores matter
Once your child comprehends the basic idea behind borrowing, you should help them understand that their credit reports and scores will grade them on how well they borrow (and pay back money). The easiest way to help them understand the concept of credit reports and scores is to explain it like their progress report and final grades. A credit report is their progress report that details anything and everything about their credit, and a credit score is a final grade that’s based on their credit activity over time (or what’s noted on their credit reports). If they are old enough, you may want to show them examples of what credit grading looks like with copies of credit reports and credit scores. If you feel comfortable, you can use your own credit as an illustration to explain what behaviors helped you earn the scores you have, or if that’s something you’re not comfortable with, you can use a sample credit report. As you go through the credit report, be sure to point out the good and bad things listed there, as well as highlight that an inability to pay back borrowed money on time could lead to poor credit grades which, in turn, can impact their ability to borrow in the future or even get things like housing or a cell phone plan.
It should be noted your child shouldn’t have any credit reports yet, but given that child identity theft is a major issue thanks to data breaches as well as familiar fraud, it’s entirely possible that your child’s identity may already be in someone’s crosshairs. Read our guide to child identity theft to learn about warning signs you should look for to determine if your child is a victim of identity theft. Also, consider freezing your child’s credit to keep it safe until they become an adult, and if you want a way to keep tabs on both your and your child’s identities, you may want to consider signing up for an identity theft protection service that offers a family plan.
Budgeting is essential
In order to be truly responsible with their finances, your child will need to know how to appropriately allocate money toward paying their bills, saving and spending. As such, you should help your child gain a solid understanding of budgeting. The easiest way to do it is with a prepaid card. These cards allow you to deposit a set amount of money into the accounts so the card can be used, then once the account balance is emptied, the card cannot be used. As you can see, prepaid cards can be a handy way to teach your child how to budget their money — you can even deposit their allowance into a prepaid card if you like. While you could provide the same lesson with cash, a prepaid card is handy because it keeps track of your child’s purchases — this means you don’t have to worry about keeping every receipt — and provides you with a statement that you and your child can go over together every month. If your child is a teen or older, you may want to consider adding them as an authorized user to your credit card, but be aware that if they are irresponsible with the card, you’ll be on the hook for their purchases.
Michael Osakwe, of NextAdvisor, has a blog where you can read more of his advice about financial matters. http://www.nextadvisor.com/blog/