Kids and money – building financial literacy and investing on their behalf

17 December 2021

reading time:  minutes

Being a parent is a huge responsibility.

We want the best for our children. When they leave the nest, most of us want to have some comfort knowing that they’re well-equipped to be happy, independent, productive people.

Part of this picture is being able to make sound financial decisions.

As a result there are loads of resources and products to meet this demand.

For instance, The Barefoot Investor for Families is a staple in New Zealand book stores.

Some of us might even want to provide our children with a head start in one form or another.

A lot of investment platforms and fund managers allow you to set up investment accounts on behalf of your children.

I’m pretty sceptical of both. At least – for my personal situation.

Congratulations

If you’re actively thinking about your children’s financial literacy and situation – they’re already lucky.

Not everyone has parents who are able or willing to go as far as read articles like this.

The fact that you care enough, and that you’re able to do so, is something to be proud of.

Congratulations. 👍

The fact that you’re able and motivated is probably more important than any specific strategy or tactic you employ.

Building financial literacy and confidence

For the purpose of this article, I'm going to contrast my views with those of Scott Pape, aka The Barefoot Investor. I don't mean this to be a major critique of the great work he does. I use it as an example to illustrate my own philosophy when it comes to helping children become financially literate and confident.

The Barefoot Investor for Families

Scott Pape’s books don’t resonate with me.

It’s not because I fundamentally disagree with him. It’s just that some things resonate with certain people, but not for others.

There are lots of things I really like about Pape. In particular, he seems like an independent soul. He is not a spruiker for financial products and institutions. He really seems to care about the interests of his readers. I’d like to feel that in this fundamental sense, we’re kindred spirits.

Having said that, I don’t think the guidance in this book is especially good. For me, it falls into the category of “sounds good” and “is what I’d like to think and do”, but isn’t super practical or relevant, at least for my family.

Jam Jars

Pape suggests that kids have three jam jars – a “splurge” jar for day-to-day spending, a “smile” jar for savings goals, and a “give” jar for helping others.

My wife was inspired by this, and set up some jam jars with the help of our children.

We started off with great intentions. And then we didn’t have enough coins one week. The kids didn’t seem to care. We got back on the horse for another couple of weeks. Then the experiment fell away.

I’d be fascinated to see if anyone has done any research to find out whether this is something that many families follow through with, and how effective this actually is.

My guess is that our story is pretty typical.

🤷‍♂️

The Barefoot Ten

Part 2 of the book revolves around “the Barefoot Ten”. It’s a list of ten things your child should have done before they leave home.

For example:

  • Promising to never get a credit card.
  • Volunteering in their local community.
  • Setting up a savings account for a home deposit.

I didn’t do any of the above, nor many other things listed on the Barefoot Ten.

I turned out okay.

I don’t mind if my kids eventually have credit cards. My wife and I have them, and they are great for our personalities and situation.

We might be in a position to help our children with their first home. But I’m not going to put funds in a savings account for this specific purpose. I want the flexibility of being able to help them in the right way at the right time. More on that later.

I don’t think our children need to do this themselves, either. I think there are other investments to focus on at that age and stage.

What about volunteering, and other things he suggests, like being able to cook low-cost, nutritious meals?

I hope they do that.

But that has very little to do with whether they’re prepared to manage their financial affairs.

That’s part of a bigger project of raising our children to be well-adjusted human beings.

If you want to raise your kids to be thoughtful, caring people who have empathy and want to help others and leave the world better than they found it, that’s awesome!

🎉

But you don’t need to make it a lesson about being financially competent and confident.

Biases, presuppositions, and incentives

Everyone has biases, prejudices, and presuppositions about the world. These are informed by our experiences, what we’ve been exposed to, our predispositions, and our incentives.

Pape and I might have the same fundamental, independent streak. However, we have different incentives:

  • Pape is an author, writing for a wide general audience. He makes money by providing general guidance to a lot of people.
  • I am a financial planner. I’m not especially interested in writing for the same type or size of audience as Pape. My economic incentive is to provide tailored advice to a small portion of people.

I suspect these incentives manifest in different ways, even if they’re not conscious or intentional.

Pape is inclined to make general comments that are broadly applicable. He may encourage you to “tread your own path”, but the specifics of what he says are more likely to be prescriptive than someone like me.

I am more likely to gravitate towards nuance, and a philosophy of “you do you”. Everyone is different, and your plan – including your broader strategy and the tactics you use in pursuit of this strategy – should be idiosyncratic and tailored to where you are, who you are, and what you want (and don’t want) out of life.

It’s probably more complex than our incentives determining our philosophies. It could be the other way around: our philosophies have informed the way we operate, which in turn influence the incentives that magnify our philosophies.

Which is a long way of saying:

When it comes to kids, I think the approach we take should be idiosyncratic and tailored to who your children are, their strengths, the things they find challenging, and what you – and they – value.

Children differ

I have two children. One thing you learn pretty quickly once you’ve had a second child is how different they can be.

The things we need to emphasise to our son, in certain domains in life, are often very different to the things we need to emphasise to our daughter.

There are similarities, but the differences are significant.

They each have different interests and learning styles.

And similarly, my wife and I have different circumstances, values, and priorities compared to our own siblings, or our friends, or anyone else.

All of these factors should inform the way we communicate with our children about money, and whether and how we help them out.

Jam Jars aren’t for us.

The Barefoot Ten might work for Pape’s family and lots of his readers. They’re not for us. My guess is that they’re not for a lot of people. If it doesn’t work for you, that is 100% fine.

"Money management" isn't a discrete topic

I don’t really see money as a discrete domain that we need to teach our children.

The way I see it, money management incorporates a lot of broader lessons I want my children to learn:

  • Maths. Budgeting and measuring your net worth is basic addition and subtraction. Compounding interest is a form of exponential growth.
  • The basics of economics, which is the study of managing scarce resources. Understanding marginal costs and marginal benefits. Understanding opportunity costs – realising that with every decision we make, there are trade-offs, including options foregone.
  • Self-knowledge. Knowing what matters to them. About what keeps them up at night. About what motivates them. Learning what they like, and what likes them. Learning to drive the personality they’ve been given.
  • The value of deferred gratification (while also making the most of opportunities when they arise.)
  • Communication. Knowing how to say “no”. Knowing how to be assertive. Knowing how to have candid conversations with people they care about, even if they aren’t easy.
  • Being productive human beings. Ultimately, investing is a form of allocating capital to its most valuable use. This is relevant for balance sheet assets. It’s also relevant to how they utilise their own energy and talents. (On this note, I differ from Pape in one big respect. I think how much money you earn can make an enormous difference on your long-term financial outcomes.)

What values do you want to express?

What values do you want to express to your children, and instil in them?

Some people want to pay for their children’s university education. Others want their children to fund their own education, take out student loans, and know what it’s like to have debt.

Some people want to help their children set up their own businesses. Some people want to encourage their children to take risks – financial, personal, and professional – as they try to work out what they like, and what likes them. Others want their children to take more secure paths.

Most people want to provide their children with a sense of security: an internal sense that no matter what happens, you – and other loved ones – will have their back, financially and otherwise.

The level and type of assistance you provide your children should reflect your own values, and how you want to communicate them to your own children. This isn’t a “right” or “wrong” thing. There might be some overlap with your friends, family members, neighbours, and colleagues. But ultimately, the values you have and how you want them to manifest, are personal to you.

Investment products for kids

A lot of fund managers provide options for Kiwis to create investment accounts on behalf of their children. 

Personally, I don’t use these facilities, and it’s unlikely that I will. I also think a lot of people do it when there’s no special value in doing so.

A nit-picky, technical objection (that flows on to a bigger issue)

Children are minors. Broadly speaking, minors can’t enter into enforceable contractual arrangements – including investing directly on their own behalf. Someone has to do so on their behalf. I believe investment providers differ in the specifics, but generally speaking, investments are made on behalf of children, often in trust or trust-like arrangements.

Whenever I think about money held on trust for children, the phrase “vested and indefeasible interest” comes to mind. The basic idea is that if money is held on trust for someone, and they are the sole beneficiary of the trust, they can take control of the assets as soon as they turn 18.

It has been a long time since I was a trust lawyer. I’ve forgotten more than I remember. I know enough to be dangerous. But my guess is that if you set up an investment account for a child, and they are really motivated, they’ll be able to access the funds that have been earmarked specifically for them when they are 18.

I could be wrong. And perhaps fund managers have or will find a way to deal with this risk. But personally, I want to have the means to help out my children at the right time in the right way. I don’t want to run the risk of them getting access to potentially a large amount of money and doing whatever their 18-year-old self is a good idea, which might be completely different to what their 30-year-old self would have wished.

I'm ambivalent about the tax benefits

Let’s say you have a high marginal tax rate. If you had a fund in your own name it would have a tax rate (PIR) of 28%. By creating an account in your child’s name, it might have a lower PIR – let’s say, 10.5%*. That sounds like a lot of money saved in tax!!!

This is a situation where it’s best to think in terms of absolute figures, rather than percentages. Let’s say you have $10,000 invested, and for illustration’s sake, let’s apply a “fair dividend rate” of 5%. This might come to $500 in taxable income. If you’re taxed at 28%, you’ll get $360 after tax. If you’re taxed at 10.5%, you’ll get $448. That’s a difference of $88 per year.

$88 of $10,000 is 0.88% per year in additional taxes. And that’s something you’re likely to pay year-on-year. And the investment is hopefully enjoying compound growth, so the amount you pay in tax should grow higher each year. When you put it that way, it’s a lot of money to forego.

But personally, I don’t think $88 or so per year is the end of the world. Especially if it means I can have greater flexibility and control over the investment. In a sense, I think $88 or thereabouts per year, for each $10,000 invested, is a pretty small price to pay to retain that flexibility and control.

* Another thing I’m a little confused about: if you invest on behalf of children, my presumption is that it must be invested on trust in some way. The “minor beneficiary rule” that applies for most trusts dictates that trust income directed towards beneficiaries under the age of 16 are taxed at 33% and not at their marginal tax rates. My understanding is that one of the reasons for this is so that people can’t direct assets/incomes towards children to evade tax. I’ve forgotten more than I remember when it comes to trust matters, and I’m definitely not a tax expert, so I’ll assume I’ve missed something that relates to PIE funds, and will take on good faith that investments on behalf of children can in fact be taxed at, say, 10.5%.

Helping out the right people in the right way at the right time

For me, flexibility and control are key.

My guess is that my wife and I will help our children out in various ways. It’s likely that we’ll help them:

  • Buy their first car.
  • Pursue education after high school.
  • With getting their affairs in order early on (for example, paying to have enduring power of attorney arrangements in place once they turn 18).
  • With personal insurance premiums early in their adult and professional lives. (In part, this is a form of enlightened self-interest, since their risks will be our risks – if something significant happened, we would feel compelled to help out, so the insurance premiums will be for our protection as much as theirs.)
  • With buying their first home.
  • In less direct ways – hopefully, we’ll provide them with a sense of security that will allow them to make professional risks, knowing that they’ll never be homeless or be unable to pay for food.
  • In other ways, as the opportunities present themselves. For example, I want to encourage and help them with setting up and running their own ventures if they show an entrepreneurial bent. Whether this involves providing guidance and support or actual capital remains to be seen.

They’re lucky to be in a position where their parents are likely to be willing and able to help out in these ways. I am aware that this isn’t the case for everyone.

(Providing my children with these advantages also conflicts with my general belief in everyone having equality of opportunity. But that’s another, much bigger, topic.)

Note that I said – it’s likely. It’s not guaranteed. I have gone as far as building some of these forms of assistance into the assumptions of our personal “flawcast” spreadsheet.

But whether and to what extent we assist will depend on various factors. For one, a driving factor will be who our children are/turn out to be, what they want out of life, what values we want to instil, and how.

I don’t want to put myself in a straightjacket today that I might regret in the future by committing funds prematurely.

Maybe it seems like I’m a control freak. To be clear, I have no interest in being a puppeteer and controlling the lives of my children. I want them to live good lives, however they define what that means to them.

But if I’m going to be generous beyond what most people can/should expect from parents, I want to be generous in my own way.

For that reason, I’m not going to earmark money for a specific purpose just yet. I’m going to build wealth in the meantime and build optionality – among other things, be in a position to help out my loved ones in the right way at the right time.

Another factor is whether we’re in a position to assist. We will calibrate our decisions to our circumstances at the time.

The better our position, the better their position

There was a period where my wife and I put money away in accounts that were notionally for our children (but still in our names). When we bought our home, we decided to use those funds as a contribution towards our deposit. Since then, we’ve been repaying our mortgage off faster instead of putting money to the side for our children.

If we can pay off our mortgage six or 12 months early because of this, that represents six or 12 months of additional savings that will better enable us to help out our children.

The more secure our own financial position, the better positioned we will be assist them in all the ways I’ve described above. My aim isn’t to earmark funds for these purposes. My aim is to be in a position where I can help, out of our own funds, as and when the need or opportunity arises.

The bigger picture – thinking strategically and helping out in other ways (hedging and managing risks)

My wife and I have recently purchased a second piece of land. It was a terrible financial decision, but will hopefully be a great lifestyle decision.

However, there is one financial aspect to purchasing a second piece of land. It’s likely that we will want to help our children get onto the property ladder. In which case, owning land is likely to be useful for this specific purpose. It’s less about maximising financial returns (which it’s not!) but is more about hedging against additional price inflation.

If property prices continue to increase significantly, then in the broader sense of things, we’ll be in a better position to help them out. If property prices reduce, then one consolation for us is that we won’t need to help out as much.

In the latter case, we might not be able to help as much. But what we’ve done in the meantime is, in a roundabout way, managed a risk on their behalf. It’s not an especially visible or explicit form of assistance, especially compared to a direct gift or cash transfer, but it’s a type of assistance nonetheless.

Situations are different

I’m NOT saying that you should do what I do.

I share my own approach to illustrate that what you do should be based on your own circumstances, and what you want – for yourselves, and for your children.

If it's not one thing to panic about, it's another

When it comes to parenting, there is always going to be something to worry about.

It’s too much screen time.

It’s the effect of social media on their psyches.

At one point, it was too much time reading books.

At another point, it was teddy bears.

Are our children going to be okay financially? That’s a huge, important question, and no wonder there are people and organisations who are willing to help, for a fee.

For people who want to sell something (with good intentions or not), there is always going to be some way to open the wound and turn the knife.

The reality is, if you care enough about your children, and you have the time and resources to think seriously about their relationship with money, they’re likely to be fine.

Instead of deferring to what I or anyone else has to say, spend some time thinking about your own children, and what you want for them.

Think of cultivating their financial literacy as one part of the bigger picture of helping them live a good life.

Think about how you want to help them, and when, and how best to position yourself to do so.

If that involves Jam Jars and following the Barefoot Ten, more power to you! If you want to create your own financial literacy curriculum for your children and teach them the key lessons, that’s great! If you or your parents (their grandparents) want to invest in an investment account that’s in their name, that’s terrific!

But don’t let anyone tell you what you should do. You know yourself. You know your children. You know what’s best for you, and for them, better than anyone else.

Just do your best. You don’t have to be perfect. Parenthood isn’t a test.

If you’re doing your best as a parent, you’re probably doing great.

With any luck, your children will probably be grateful one day.

In the meantime, please accept my gratitude for doing your best as you raise the next generation, who will be the stewards of the world when we are in our twilight years. If you care enough to have read this far, you’re probably doing fine.


Tags

children, FC, financial confidence, financial literacy, investing, kids, managing risks, minors


About the author 

Sonnie Bailey

Sonnie provides financial planning services via his business, Fairhaven Wealth (www.fairhavenwealth.co.nz). Fairhaven Wealth provides independent, advice-only, fixed-fee financial planning services. Sonnie is also a “recovering lawyer”: he has specialised in financial services, trusts, and estate planning.

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