Wednesday, October 27, 2010

Never Too Young to Learn: Time – The Most Important Factor in the “Money Game”

I wrote a post earlier this year about an experiment that I was doing with my seven year old son (now eight years old) to teach him about saving money and investing for his future. The post describes the steps in detail that I took with my son to start him investing in his own Roth IRA. We found that one of the main rules that you must follow in order to qualify for a Roth IRA is that the money must be “verifiable earned income” – in other words you must have proof that the money was earned and not just a gift from grand mom. So, in our “experiment”, in order to prove “verifiable earned income”, we decided to set up a business for my son, keep good documentation on all income, and then later file taxes on that income. You can read about all the steps we took at The Roth IRA – Not Just For Grownups Anymore!

Just recently, my son hit a milestone in the amount of income that he earned for his newly created business for this year. He cleared his first $250.00 – which is special because it is the minimum initial investment for the fund that we were looking to invest in. Now, I know $250.00 is not something to get too excited about, and my son wasn’t that excited about it either. He was starting to get a little tired of me always trying to find him odd jobs that he could make money doing – from shoveling snow, to spreading mulch, to cat-sitting or tomato-watering or mail-collecting while the neighbors are on vacation, to clearing the yard of dog poop, to mowing the neighbor’s lawn, to cleaning the bathrooms, to weeding. So, I decided at this point I needed to inject some excitement into this “experiment” and give him his first real money lesson.

I asked my son, “Would you like to know what this $250.00 could be worth in the future if you just invested it and left it alone until retirement?” He was pretty curious (and so was I) and he responded with an excited “Yeah!” So, I pulled out my financial calculator, handed it to him and let him do the driving. The first thing we needed to calculate was the number of years he had left until retirement age. We subtracted his age, 8 from the retirement age, 65 and got 57 years (he didn’t need the calculator for this one). Next, I helped him compute five very possible scenarios for his investment:
  • $250 working at 3% rate of return for 57 years would accumulate to $1,347.91
  • $250 working at 6% rate of return for 57 years would accumulate to $6,924.28
  • $250 working at 8% rate of return for 57 years would accumulate to $20,095.28
  • $250 working at 10% rate of return for 57 years would accumulate to $57,190.39
  • $250 working at 12% rate of return for 57 years would accumulate to $159,722.94!
My son had fun pushing in the numbers on the calculator, and he got more and more excited as the rate of return went up. By the time the exercise was over he had mastered the calculator. I told him that 12% is actually very possible over that long of a period of time, based on historical stock market evidence. Also, I mentioned that since the investment would be a Roth IRA, the money would be able to be withdrawn totally tax free! But, not only did he have fun, I think he actually got it – he realized that you can invest a relatively painless amount of money now and in the future it can turn into a pretty significant amount of money because of the powerful compounding effect of time on money.

This little exercise sort of changed my son’s attitude towards work in a positive direction and revived his entrepreneurial spirit. He saw what a measly $250.00 could possibly do over time and then you could just see the gears in his mind start turning as he started calculating his own scenarios of what the numbers would look like if he was to invest even more money.

The moral of the story: Don’t be afraid to teach a young child about money. Children are naturally inquisitive, have a great imagination and they are usually eager to learn. There are really only three factors in the “Money Game” – money, interest and time – where time is the most important. And children have the most important piece to the puzzle already – Time! Teaching your child early and celebrating their milestones can go a long way towards ensuring a better relationship with your child, taking advantage of more compounding periods for their money to grow, instilling in your child good money habits and work ethic as well as providing him with a more secure financial future.

I’d like to end on a quote that I thought was appropriate for this topic from the late great Jim Rohn: What should a child do with a dollar? Here's one philosophy: It's only a child and it's only a dollar, so what difference does it make? Wow, what a philosophy! Where do you suppose everything starts for the future? Here's where it starts—it starts with a child and a dollar. You say, “Well, he's only a child once. Let him spend it all.” Well, when would you hope that would stop? When he's fifty and broke like you?

I'm so excited to share this information with you. If you have enjoyed the information or feel that it would benefit someone else, please share it. If you have any questions or comments, please feel free to contact me.
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