July 2006

Does your teen have a mind for money? Take this simple quiz to find out.

You advise your daughter to put some of her savings into a CD. Does she:
(a) Ask for a ride to the bank
(b) Immediately head to the nearest music store

If you answered (b), you aren’t alone. Most youngsters today are ill-prepared for the financial responsibilities awaiting them in adulthood. Now’s the time to teach them lessons you only wish you’d known at their age.

Take baby steps
Think back to when you taught your little one to ride a bike. You started slowly and safely with a tricycle before moving up to training wheels and, eventually, a 10-speed.

It’s no different with money matters. The ride begins with a simple savings account to get young earners into the habit of setting aside part of their income.

“I suggest opening a savings account in their early teens, when they first make money from babysitting or mowing lawns,” says David Harper, a private banker with Northern Trust and father of two young adults.

As account owners, kids should be in charge of making deposits, maintaining the passbook and reconciling it against bank statements. Along the way, they’ll see their balance grow through the magic of compound interest.

“It also teaches them financial inde-pendence,” says Harper. “It’s a valuable experience for teens to come into the bank and deposit their own money into their own account.”

That account can serve as a spring-board to more complex and demanding responsibilities, Harper says.

The next step is usually getting an ATM card drawn against the savings account. Before doing so, be sure kids understand exactly how, when and where to use it. Do they know the fees involved? Can they be trusted with the card and its PIN? Will they take time to record every transaction?

The final step is converting the savings account into a checking account at age 18, just in time for teens entering college or the work world.

“They keep the same account number and register, and we just order a supply of checks,” says Harper. “With several years of experience already under their belt, the transition to checkwriting is usually a smooth one.”

Turning savers into investors
With their bank account converted and personal earnings on the rise, older teens often need a new place to house savings from summer employment that can amount to thousands of dollars. Harper recommends a Roth IRA.

“Not all parents are eligible for a Roth IRA, so they don’t realize that a child with earned income is,” he says.

To encourage investing, consider matching every dollar your teen either earns or contributes to the Roth IRA. Together, your combined contributions can equal the child’s W-2 income up to a current annual limit of 4,000.

“If parents can get that seed money planted at 18 or 19, kids have 40 or 50 years of tax-free compounding ahead of them,” Harper says. “Even a small amount now can make a huge difference at retirement.”

Of course, retirement may be impossible to fathom for teens who view 30 as over the hill. For them, Roth IRAs offer another attractive feature—the option to pull out as much as 10,000 without taxes or penalties for a first-time home purchase.

Stock mutual funds are usually Harper’s vehicle of choice for novice investors 18 and older. The key is getting them focused on buying the company, not just its products.

“I’ll ask if they recognize any names among a fund’s top 10 holdings,” he says. “Kids get excited about owning different companies they come across every day.”

Like any investor, teens must understand the risks before taking the plunge. You can help by talking about the market dips you’ve experienced and the time it took to recover. Another approach is to have kids track stocks of interest in the newspaper or online, so they get a sense of the fluctuations before committing real money.

Giving them credit (cards)
While investments are a necessity for any financial plan, credit cards are more of a necessary evil. Every teen wants one, and most will need one. The question is when.

High school? Minors need an adult co-signer to get the card and bills, but you’re legally responsible for the account.

Harper doesn’t like this arrangement because transactions aren’t applied to the child’s credit history. Instead, he suggests waiting until 18, when full-time college students qualify under their own signature.

No matter what the age, it’s critical to set ground rules up front about using the card. For example, emergencies and planned purchases are allowed. Pizza slices at the mall aren’t.

As a rule, teens should view plastic as merely a substitute for cash. In other words, it stays in their pocket if they don’t have money to pay the balance in full.

Stress the importance of paying on time to create a good credit score. Explain how credit card companies profit from late fees and revolving debt. Point out that convenience checks, payment holidays and cash advances are only meant to deepen that hole of debt.

Set a good example
Bear in mind that those lessons probably won’t pack much of a punch if you’re not practicing what you preach.

Even the best-intentioned teens will occasionally tune out what you say, but they’ll always pay attention to what you do. If you want them to grow up to be sound money managers, become one yourself. Let them see you budgeting, saving and making wise decisions for the future.

Not only will you teach a lifetime of good habits, you’ll improve your own financial situation in the process.