When it comes to financing our children’s educations, we have a lot of expectations of ourselves, and probably of our kids too. We expect them to think about college at least as much as we do and to understand that not only is it an expensive proposition but that they will need to participate in both planning and paying for their education. One stumbling block that we may run into when talking to our kids about how their college is getting paid for is that they may not yet have a solid grasp on some of the concepts that we consider basic, or at least familiar.
In the fast-paced world of the American teenager, instant gratification plays a big role. They spend what they get and they want what they want and they want it NOW! When we talk to our college-bound kids about money, then, a couple of really crucial concepts that we need to cover are the time value of money and opportunity costs. Both of these notions require a level of patience that is rare in, and in many cases antithetical to, the lives of our teenagers.
Time Value of Money
The time value of money is just another way of looking at how the money you put away grows over the period time that you save it. The earlier we start saving, less of our income (if all goes well!) will need to be earmarked for saving and can be spent elsewhere. Conversely, if we start saving our money for college later, it will not have as much time to grow and we’ll have to save more in order to get similar returns. This is the time value of money.
In explaining the time value of money, two of the most important things we need to make sure our kids understand are saving and investing, coupled with the notions that compounding interest and reinvestment are powerful tools. I’m sure that at many levels our kids get the concept of putting away money for future use. In fact, they probably covered the topic in high (if not junior high or middle) school. But theoretical notions of what happens to the money after it’s been “saved” pales in comparison to a real world visual aid like an account statement.
When I talk to my kids about paying for college, or savings in general, I try to create a sense of urgency in their minds for saving. I impress upon them that as much as I want them to go to school that the process must be a partnership, and that if they get (or have) a job or an income, whether it’s babysitting, raking leaves or pouring triple lattes, they – like us – should be putting away a good portion of their income for use during their college years. Then, each month or quarter, if it’s more appropriate to the account, I sit down with them and look at their statements.
For bank accounts, at least regular savings accounts like my kids have had since they were born, the power of compounding interest is considerably less impressive than it used to be. If you or your children are putting money into a money market, savings or certificate of deposit account at a bank, it may make some sense to look at several statements going back over a period of time. This way, your son or daughter will be able to see how their (or your ) accounts grow with the compounding of interest and additional periodic deposits.
Of course, if you or your kids have a Section 529 educational, or other type of investment, account in which the money is deposited in mutual funds or other types of equities with a dividend reinvestment component, your regular check ins will be more dramatic. On the other hand, during those months or quarters when the market has been down, you’ll be able to pass on the valuable lessons of market volatility, unguaranteed gains and saving or investing over a long term. Which brings us to opportunity cost.
When we try to instill the virtues of patience and frugality into our kids, we will have to help them examine decisions and choices. One way of doing this is opportunity costs. Typically, an opportunity cast is not a concrete figure, although it weighs the value of one action against another. For example, if I decide to go out to dinner with a friend tonight, I will miss my son’s basketball game. Because my son’s game ultimately has more value to me, I am willing to give up the dinner: that is my cost of attending the basketball game.
When talking to our kids about saving for college, the concept of opportunity cost is important. If they buy $100 worth of CDs during their junior year of high school, the opportunity cost will be the lost interest/investment gains on the $100 and their inability to use that $100+interest in college for an emergency.
If we are able to impress upon our kids the importance of the dual concepts of the time value of money and opportunity costs at a younger age, they will be better partners in saving for their own educations, as well as better stewards of their own money. Hopefully, they’ll call less often for loans, as well.