4 Money Lessons to Teach Your Kids Before College
Once kids reach their junior or senior year of high school, it’s time to teach them how to handle their finances. That’s especially true as they think about college costs.
Teens who learn about money and financial independence are in a better position to understand the cost of their education. These lessons about money will serve children well for the rest of their lives.
1. Know the Real Cost of Debt
One way or another, young students will likely learn about debt—nearly two out of three college students graduate with student loans.¹ Ideally, you want them to understand the real cost of debt, and not be hurled into a trial-by-fire situation.
Saving for College: Bring Your Kids in on the Plan
One of the best ways to teach children about debt and the impact of interest is to include them in conversations about college costs.
2. Understand Compound Interest
A crucial part of financial literacy revolves around interest rates. Say you want to show the long-term impact of a 5% interest rate on a student loan. A $1,000 loan, at 5% annual interest, means you would owe $1,050 after a year and $1,102.50 after two years.
On a $50,000 loan, the debt grows to $52,500 after a year, $55,125 after two years and $63,639.50 after ten years, with regular monthly payments of $530.33.
Demonstrate with Larger Loans
A $100,000 loan, at a 5% interest rate over 20 years, ends up with more than $58,390.40 in interest. That’s assuming regular monthly payments of nearly $660 a month.
Examples like these demonstrate the power of compound interest, which is the impact of the interest rate over time. Each year, that interest rate hits the balance owed, including the principal amount and unpaid interest. You may show them this impact with a student loan, using a student loan calculator.
Don’t Forget Credit Card Interest
Helping teens to see the impact of interest on the cost of their education will help them with credit cards too. The average minimum annual percentage rate (APR) on a credit card is 15% to 19%.² If you have a $1,000 balance and pay only the minimum balance each month, that would cost nearly $600 in interest with a 19% rate over 64 months. Seeing the numbers teaches the importance of paying off the credit card in full each month.
3. Build a Safety Net
The sooner children understand the value of an emergency fund, the sooner they may reach financial independence.
To teach them about the emergency fund, start with budgeting. Have them record their spending, even if it’s only small amounts, on a spreadsheet or budgeting website. This gives them a view of their total spending.
You also want to explain the difference between recurring bills for necessities, like rent and electricity, versus discretionary spending, like new clothes or eating out. By understanding the difference, children see what they need to prioritize and where they can adjust if money is tight.
Typically, you want an emergency fund to cover three to six months of necessities in case of a sudden job loss. Emergency funds also can be used to cover unexpected expenses, like a fender bender or medical bills.
4. Tiptoe into Investing
Lessons on debt and compound interest will serve teens well when you teach them about investing. Only instead of working against them by increasing the amount of debt, compound interest can work for them by helping their money grow. Also, after setting up an emergency fund, they will know how much money they can set aside to invest.
The Institute for College Access & Success, Student Debt and the Class of 2018, Sept 2019.
Average Credit Card APR, U.S. News and World Report, June 15, 2020.
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.