The 4 Steps to Raising A Financially Literate Child

25 May 2011 No Comment Print This Post Email This Post

This guest article was written by Card Hub’s founder and CEO, Odysseas Papadimitriou. Card Hub is a leading personal finance website, dedicated to helping consumers find the best credit card deals.

Raising financially literate children isn’t so different from raising kids who can tie their shoes, ride a bike or swim. Each requires commitment, patience, motivational skills and hands-on instruction. There is one key difference, however: most parents make it a priority to teach their kids how to get dressed in the morning, pedal themselves around and avoid drowning, but relatively few actually focus on money management. While this might be a surprise given the importance of credit scores and the potentially crippling effect of debt, it shouldn’t be considering basic consumer mistakes helped contribute to the Great Recession. Perhaps this will serve as a wake-up call though, and financial literacy will soon join the standard curriculum parents teach their children, right along with the ABCs and multiplication tables.

The Theory

The principle behind teaching your children fiscal responsibility is simple: give them real-life experience in a safe environment in order to develop skills directly applicable to financial independence. In order to accomplish this, you must familiarize them with different spending vehicles so nothing will seem foreign when the stakes are higher, give them allowances so they can pay for some of their own expenses and learn just how far money really goes, and implement a cause-and-effect system whereby they are rewarded for proper use and penalized for irresponsibility.

Practical Application

Step 1 – Prepaid Card:

Like with teaching your children how to tie their shoes or ride bikes, it’s important to start small with a lot of hands-on advice in a low-pressure environment. So begin your kids’ financial upbringing by giving them prepaid cards when they start high school, loading a predetermined amount of money twice a month, and requiring that they pay for certain discretionary purchasing (e.g. movies, clothes, etc.) with this money. Prepaid cards are great tools to begin this process with because you not only control how much money your kids have access to, but—since most prepaid cards allow for online account access—you can also use your children’s actual spending habits as a teaching tool.

If they consistently make wise purchases and avoid blowing their allowances too quickly, feel free to move on to Step 2 after a few months. Of course, if they don’t, decrease their allowances and remain on Step 1.

Step 2 – Cash:

Don’t forget to give your kids a reward when they matriculate to Step 2 (perhaps a cash bonus) because this will both validate their efforts and motivate them to continue working hard. Step 2 calls for you to increase your children’s allowances (which will now be in cash) so they can pay for more of their own things. This serves three purposes. First, decreasing the frequency of the allowances will test the kids’ progress and require them to develop better budgeting skills. Second, increasing both the amount of the allowances and the responsibility your kids have lets them feel more independent, something teens crave, while also allowing you to remain in control. Third, giving your kids cash lets them to gain comfort with a different method of payment and forces them to keep track of and avoid losing their money.

Again, when you feel your children are ready, bring on Step 3.

Step 3 – Checking Account:

Opening checking accounts in your children’s names is a great next step because it will give them practice writing checks without bouncing them and making purchases with a debit card without overdrawing their accounts. Just deposit slightly more money each month than you gave your kids in Step 3, expand the costs they are responsible for, and observe from a distance. It’s important that you remain available to help but avoid meddling because your kids need to get used to not having you there as a safety net. If they do end up making mistakes though, you might want to move back to Step 2 because too many bounced checks or account overdrafts could result in them being unable to obtain another checking account for a while. When they’re ready, progress to the fourth and final step in the process.

Step 4 – Credit Card:

Use of a credit card is the last step because the consequences of potential mistakes are more significant. So before co-signing for your kids’ credit cards or making them limited authorized users on your account, make it abundantly clear that they must pay their balances in full and on time each and every month. If they can’t manage this, demote them to Step 3 and lower their allowances. If they can, they’ve learned how to spend within their means and make proper payments and are therefore truly ready to head off to college and put the lessons you have taught them into practice.

Final Thoughts

Being directly involved in your children’s financial education is perhaps now more important than ever. The CARD Act restricted the access people under the age of 21 have to credit. As a result, more and more young adults are cutting their fiscal teeth right around the time they graduate college and begin their careers. That’s simply a lot to handle. Luckily, it’s preventable as long as you’re willing to co-sign for checking accounts and starter credit cards or make your kids authorized users. So start early, stay involved and give your kids an opportunity to learn and build some credit in a safe environment. Who knows, maybe this will even save your kids from experiencing another recession in their lifetimes.