Roughly 68% of Americans feel that saving for retirement is harder than they anticipated. Some 25% of all middle-class Americans “get depressed” when even thinking about it. And 40% of millennials have no idea how much money to save. The most frightening statistic: 21% of Americans think that winning the lottery is the most practical way for them to fund their retirement.
I discussed these problems and the financial behavior of investors with Rob Pivnick, a financial literacy advocate and author of “What All Kids (and Adults Too) Should Know About…Saving & Investing.” His message is that parents should teach their children the right habits as early as possible, so they don’t become one of these statistics. And it doesn’t have to be difficult. Here are 10 easy ways to teach your children about smart investing.
1. Start Them Off Early
Starting to save as early as possible is the easiest way to let your money work for you. In fact, this is probably the number one thing you can teach your children about money.
Consider this example from Rob’s book comparing two savers: One starts saving when he is 20 years old, while the other waits until she is 30 years old. Each one saves $100 per month until they are 60 years old, and they both get the same 8.5% return. The early saver will have $406,825. The saver who waited ten years will only accumulate $166,339. That 10 year difference results in over $240,000 more growth! But the difference in the amount contributed was only $12,000 — compound interest made up all the rest. So, encourage your children to start investing now.
2. Don’t Try to Beat the Market
Your kids should want to be average — at least when it comes to investing. It is better to embrace the market than try to beat the market. It isn’t very often in life that you won’t tell your children to try to be the best, but when it comes to investing, teach them to be average. Passive management, or indexing, is an investment approach that tries to match the performance of the market as closely as possible rather than try to beat it.
Over the long term, it is impossible to consistently beat the market without taking on additional risk. Over just about any historical five year period, passive index funds beat actively managed funds. Over the last five years, for example, only 20% to 35% of actively managed funds beat the benchmark for their category. The professionals aren’t smarter than the market. And neither are you (or your kids). It’s a humbling fact, but still a fact nonetheless. (See also: 5 Investors With Better Returns Than Warren Buffett)
3. Minimize Expenses: Invest in Low-Cost Index Funds
Actively managed funds have an average expense ratio of a full percentage point higher than passive funds. One percent may not sound like much, but over the long term it becomes much more significant. How does this translate into lost dollars? Well, from another example in Rob’s book, if you invested $100,000 over 30 years at an average yearly growth of 8.5%, paying for those higher fees would cost you approximately $280,000. (See also: 3 Steps to Getting Started With Index Funds)
Everyone should know that past performance is no indication of future returns. But does everyone know that the most accurate predictor of future returns is low fees? When looking at factors like past performance, fees, and Morningstar ratings, expense ratios are the only reliable predictor of future performance.
4. Think Long Term: Buy and Hold Is the Best Strategy
The average investor’s annual return is around 4%. That’s compared to the historical average market return of 8.5%. Why? Because we tend to invest emotionally — which causes us to buy high, and sell low (instead of the opposite).
Emotional investing is a losing strategy. Don’t fall into this trap — teach your children to stick to their long term plan and ignore the daily market swings.
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