Whether they get money from a part-time job or from birthdays and holidays, teens who start a money-saving habit and learn to delay gratification now will be better prepared to manage their money and deal with unexpected expenses in the future.
Some parents demand that their teen sets aside a certain percentage out of every paycheck. But what happens when you aren’t there to tell them what to do with their money? Or worse yet, what if your kids grow up to have years of pent-up resentment over forced savings and spend it all when they are finally independent?
This is why it’s important to encourage teens to save on their own and provide incentives for doing so but also make sure they understand the why of saving money.
Why Should Teens Save Money?
Saving is key to reaching financial goals such as buying a car or a house or paying for a vacation. Talk to your teen about how you worked towards those goals yourself and the trade-offs you made along the way. Forgoing a trip to the movies or a pair of designer jeans is more appealing when it helps your teen see how they’re getting closer to a goal such as a spring break trip or a car.
Compound interest is another great reason for teens to start saving now. That’s when you earn money on your original investment and on any earnings (interest) from that original investment. When interest is reinvested, the principal (amount in the account) grows or compounds over time. The longer money is invested, the more time it has to grow. By starting early, teens have a huge opportunity to grow their money over the next several decades.
Making money on your original investment AND any earnings
Additionally, if your teen has earned income, they can contribute to a Roth IRA. Let’s say from age 10 to 18 your kid earned $2,000 every year from mowing lawns, babysitting or a part-time job and put that money into a custodial Roth IRA.
If the account earned a hypothetical 6% average return each year, they would have over $386,000 by the time they turned 65, even if they never put in another cent after turning 18. Not only is that a sizeable return on a small investment, it could impact their future. That money could be an emergency fund in college, a down payment on their first home at 30, college savings for their own children at 40 or 50, or a more comfortable retirement at 65.
Account Value at Age 18
$2,000 added annually from age 10-18, with hypothetical 6% average annual return over 8 years.
Value at Age 65 (no more investments)
$20,983 starting balance with no additional investments, with hypothetical 6% average annual return over 50 years.
Hypothetical calculations assume reinvestment of all gains, dividends and interest, and does not include fees, expenses or taxes. If all taxes, fees and expenses were reflected, the reported value would be lower.
This hypothetical situation contains assumptions that are intended for illustrative purposes only and are not representative of the performance of any security. There is no assurance similar results can be achieved, and this information should not be relied upon as a specific recommendation to buy or sell securities.
Source: American Century Investments Compound Savings Calculator. Financial Calculators from Dinkytown.net. ©1998-2021 KJE Computer Solutions, LLC.
How to Encourage a Savings Habit
Once your teen understands why saving is important, here’s how to support them in creating a lifelong habit.
Discuss wants versus needs.
Understanding the difference between wants versus needs is a key part of saving. Your teen needs clothing, but pricey designer labels are probably a want. They might need a computer or tablet for homework but want the latest model with all the bells and whistles. Explain that it’s OK to spend money on wants, but it shouldn’t mean giving up something you actually need. And if you’re going to spend money on a want, it should be something you really want, not a fleeting interest or a fad.
Set a specific goal.
Encourage your teen to save for something that excites them, whether it’s a new tablet, a skateboard, concert tickets, or something else. By working toward a specific goal, they will develop the discipline needed to achieve sophisticated savings goals as they mature. Have them figure out how much money they will need, how much they can save each week, and how long it will take to reach their goal. Then they can track their progress over time.
If your teen doesn’t have an item or experience they want to work towards, set a monetary amount as their goal instead. This amount should be realistic but also high enough that they can feel a sense of accomplishment at reaching that goal.
Help them stretch their dollars.
Saving money also means making smart purchases so money goes further. Before your teen buys a video game or a pair of earrings, show them how to comparison shop and look for coupons. If they’re shopping online, maybe leave the item in their online shopping cart for a couple of days while they think about it. Some online sellers send discount codes to consumers who leave an item in their cart without checking out, so this is another potential way to save money.
Also challenge your teen to find low-cost or free alternatives to some of the items on their wish list. Do they need to buy everything they want, or can they borrow it? Many public libraries offer a selection of current movies and video games cardholders can use for free.
Just as some employers offer a match on funds invested in a 401(k), you could offer to match money your teen puts into a savings account to reinforce this habit and help their money grow. In the example above, if your teen earns $2,000 per year and they put $1,000 into an IRA, you could make a matching contribution of up to $1,000. Or if your teen is saving up for a car, they might not want to buy a reasonably safe vehicle on their own, but you could match their contribution.
You could also offer rewards for maintaining a certain balance in their checking account so they aren’t tempted to spend that money. That said, allowing your teen to spend money and experience buyer’s remorse can be a helpful (if a bit painful) lesson for them to learn.
Helping your teen understand savings and compounding now prepares them for the future. For more on starting your child or teen’s financial education, check out Raising Financially Aware Kids.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
You could lose money by investing in a mutual fund, even if through your employer's plan or an IRA. An investment in a mutual fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
Please consult your tax advisor for more detailed information regarding the Roth IRA or for advice regarding your individual situation.
Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.