Posted by Hakyun Morrissey .
Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow?
a) More than $102
b) Exactly $102
c) Less than $102
This is the first of the “Big Three” questions, widely used to measure financial literacy–meaning, the ability to manage everyday finances like paying off credit cards and shopping around for favorable financial terms. If you struggled to get the right answer (a), you’re certainly not alone. A lot more women than men said that they didn’t know how to answer the Big Three.1
People who score well in financial literacy tests are more likely to engage in retirement planning and saving, and are more likely to invest smarter in their retirement plans. The Pension Research Council (PRC) has found that 30-40% of retirement wealth inequality can be accounted for by financial knowledge.1 Therefore, the PRC’s goal is to have every high school student attain at least a minimum competency in financial education. I agree that financial literacy should be taught and tested in the classroom, but I also believe that the most powerful lessons can only be taught outside of the classroom.
Classroom knowledge vs. real-world smarts
The ideal thing to do with a money gift is to put it in the bank–I learned that much from my elementary school teacher. But all these ideal scenarios came from the pages of a textbook. I became a whiz at math and compound interest, and understood that saving pennies was better than spending them on candy; however, all this knowledge was abstract and disembodied from everyday life.
What I’ve since learned is that you can only attain financial literacy once you have some financial resources to be literate with. Our first taste of solvency often comes with our first allowance, or monetary gift. How you handle these early dimes tends to form the blueprint for how you’ll handle dollars later on. As a parent of two young children, I’m making the most of this opportunity to teach them skills that will help turn them into financially savvy adults. And if you’re a young adult who missed the basics the first time around, it’s never too late to learn:
Saving makes you successful. Making my children wait for a toy they want now isn’t just a stern lesson in patience. Saving for the future is a virtue in and of itself. When I meet 18- or even 28-year-olds who tell me that they can’t save, what they often mean is that they won’t save–it’s a choice they make, a value judgment. Perhaps they were never taught to truly appreciate the virtue of saving. Maybe they never had the opportunity to experience the benefits of saving for a long-term goal, nor tasted the fruits of compound interest. By opening a savings account for my 8-year-old, I want to teach him the value space of sacrificing an immediate pleasure for an even bigger one in the future, of giving up one marshmallow now for two later. To sweeten the pill, I need to show him that…
Saving is fun. My 5-year-old daughter has a pink piggybank, my 8-year-old son a green one. Both are translucent enough to see inside of. For her, there’s a “wow” factor in seeing the money accumulate–she loves how heavy it feels. Old enough to own an actual bank account, my son watches how his money goes in, and how his balance goes up. It’s a nice feeling. When I was a child, you’d get a small, bound paper passbook with your savings account, making my possession of an account all the more tangible. Just as bibliophiles favor touchable, smellable tomes to their digital equivalents, I like having a physical object for nostalgia’s sake. And when it comes to teaching kids, I find it to be a more effective tool than even the most well-designed app.
Money is nothing to be afraid of. “Chrometophobia” has nothing to do with colors or Internet browsers; it’s the fear of money. Though “phobia” might be too strong a word, many people have at least an aversion to financial matters. As a parent, you can demystify grown-up stuff like investing and credit cards for your children early on. The more conversations you have with your 8-year-old about money and the market, the less scary they seem. It’s amazing how many adults think of finance as some sort of boogeyman, and the stock market as some kind of casino. Many of my clients only begin paying attention when forced to by their first paycheck. We need to get people attuned to finances long before that, in high school or college. In my opinion, you’re never too young to learn the basics of financial responsibility. Money worries can be one of life’s great misery makers, so it’s your duty as a loving aunt, uncle or friend to encourage not only thrift, but also for our loved ones to be unafraid of finances.
Every treat has an opportunity cost. Treats don’t just fall out of the sky (or down the chimney). They cost money–money that might otherwise have been invested. You don’t need to take away the magic of gift-giving, nor reduce everything to its monetary value, in order to teach your child about financial trade-offs. You can simply empower your child to make choices. Chances are that most of the time he will opt for the toy, but every now and then he may decide to save instead (remember, you’ve already convinced him that saving is fun). On his last birthday, I gave my son the option of spending $200 on a party or $100 on a smaller gathering, with the remaining $100 put into his savings account along with a parental match. 8-year-olds are surprisingly open to the idea of deferred gratification, if you add a sweetener.
It takes money to make money. Compounding is such an abstract concept that many adults struggle to fully grasp it. Kids, even more so. That’s because the benefits become more apparent over the long term. When I show my 8-year-old what we’ve deposited compared to his end balance, he does get the basic idea that money can grow, much like his own height, as evidenced by the purple chalk marks on the basement doorframe. But his savings account doesn’t experience the same dramatic growth spurts. To better illustrate how compound interest is “money on top of money,” I showed him performance charts from my 529 college savings plan, opened on his behalf eight years ago, and therefore, more impressively compounded. (It helps that the funds were tied to stocks, during the second-longest bull market on record).
Don’t be afraid to get help. That help may come from technology, which is becoming sophisticated at correcting our human flaws. But first you need to take a good look in the mirror and be honest with yourself about your financial flaws. The more honest you are, the likelier you are to put guardrails in place to facilitate saving, such as automated payments.
While reading and math are basic life skills taught in elementary school, it mostly falls on parents and loved ones to teach financial literacy. And if you missed out on that as a child, it’s up to you to learn now. The good news is that help is out there–in the form of how-to videos online, free one-on-ones with a TIAA financial advisor, and free Financial Essentials workshops. Because as any parent knows, hands-on lessons are the best.