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3 Financial Lessons Parents Must Teach Their Children (Because Schools Probably Won't)

By Sean Williams – Feb 6, 2016 at 2:01PM

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A recent study suggests that we can't count on schools to teach our children how to become financially literate.

Image source: Flickr user AFS USA.

The United States has the highest GDP in the world, and arguably one of the best standards of living, but when it comes to financial literacy we're only middle of the pack among developed countries. Based on the Global Financial Literacy Survey released in November from Standard & Poor's Rating Services, the U.S. ranked 14th overall, with a financial literacy score of 57% on a five-question financial literacy test. For context, that placed the U.S. behind Australia, Germany, Netherlands, Canada, Sweden, and the U.K., to name a few countries.

U.S. schools don't get a passing grade
Where does our lack of financial literacy originate from? According to the Council for Economic Education, you don't have to look any further than our nation's schools.

Image source: Flickr user Walt Stoneburner.

The Council for Economic Education runs a biennial survey of all 50 states to analyze how many mandate that their students take courses in economics and personal finance. The findings, which were released to CNBC this January, showed that only 20 states currently mandate students take economics -- that's down two from 2014 -- and only 17 require students to take courses in personal finance. Furthermore, only 16 of the 20 states mandating an economics course require some form of standardized testing of economic concepts. That's bad, and it certainly might explain why savings rates in the U.S. are lower than in many developed countries, as well as why so many baby boomers are entering retirement with potential money shortfalls.

The Council for Economic Education did note one positive point: all 50 states include economics in their standard K-12 curriculum, and 45 states include personal finance in the K-12 curriculum. However, this still doesn't negate the very real potential that schools aren't teaching children the real-world financial lessons they need to know before they graduate high school.

Three financial lessons parents must teach their children
In many cases, the onus of ensuring that children have the tools and knowledge necessary to succeed financially likely falls back on parents. Here are three financial lessons all parents should ensure they teach their children.

1. How to open a bank account and balance a checkbook
High school graduates may be able to tell you all about the War of 1812, but chances are most don't have the faintest clue about what it takes to open a bank account, or to balance a checkbook. Why? Because as we saw from the data above, it's not something that's being taught in most U.S. schools.

Image source: Flickr user Carissa Rogers.

Yet opening and managing a bank account can be one of the most effective tools for children to understand the value of money and the concept of saving. There's nothing wrong with introducing a piggy bank to a child to encourage them to save, but in the real world people aren't stuffing money under their mattresses -- or at least I should certainly hope they aren't.

A practical example would be to open a savings account at your local bank or credit union under your child's name. It's also probably a good idea to look for an account that requires no minimum balance and doesn't charge monthly fees, because the opening balance for your child is probably going to be nominal.

From this account you can build a number of important financial habits starting at a very young age. You can teach financial diligence by having your child check their statements once monthly, as well as manage their checkbook; they can be familiarized with the in-branch or online deposit process perhaps once or twice a month; and they can be taught about the concept of earned interest over time.

For teenagers, the introduction of an ATM card would be a logical next step. Once the foundation of monthly account management has been established, real-world responsibility can be added with an ATM card that, of course, parents could monitor.

2. How to wisely and effectively manage credit
Secondly, parents need to teach their children about the importance of credit and how to manage their credit effectively.

Image source: Pixabay.

A person's credit score can actually have a far bigger impact than most people may realize. In addition to a credit score determining your lending rate on credit cards (or whether you can even qualify for a credit card), your credit score will be closely analyzed by financial institutions when buying a home or renting an apartment, when attempting to finance a car, and perhaps even applying for a job. A poor credit score can make it very difficult to land certain jobs or to find a place to live.

The good thing is that if you've already opened a savings account for your child and they understand the concept of earned interest, explaining the concept of credit, or paying interest on money borrowed, should be straightforward. By a similar token, if your child has also been closely monitoring his or her spending habits in a checking or savings account, responsible credit use shouldn't be too difficult to teach.

The big challenge for parents will be in teaching their children about avoiding paying just the minimum. A 2011 Harvard study conducted by Dennis Campbell that looked at a 30,000-plus member portfolio of one credit union found that just 8% of members were on track to pay off their debts within 36 months or less. That means 92% of cardholders were likely to pay substantial amounts of interest over their lifetime, which also makes the true cost of the goods and services they buy much more expensive. 

3. How to use compounding to your advantage
Lastly, it's important for parents to teach their children how to invest for the future. A savings account is a great starting point for an elementary-grade student as it teaches responsibility and the concept of earned interest. However, the best financial lesson you can teach a teenager in middle school or high school is the concept of compounding.

Image source: Pixabay.

As you're probably well aware, the stock market hasn't had a great start to the new year. In fact, the broader market had its worst two-week start to the year in recorded history. Yet widen the lens a bit and things don't look nearly that bad. In fact, every single stock market correction (not including our ongoing correction) since the dawn of the stock market has been completely erased over time by economic expansion and the optimism of investors. Teaching your children that this long-term view can create prosperity is the lead-up to discussing compounding.

By compounding we're talking about reinvesting earned income, whether it be a dividend or interest earned, back into the same investment. As it relates to stocks, reinvesting dividends can allow you to buy more shares of stock, leading to a larger dividend, leading to more stock, and an even larger dividend, and so on. Over time this strategy can build substantial wealth.

As much as we'd like schools to teach these concepts to children, parents shouldn't count on them to do so. Teaching your children these key financial lessons could be the greatest and most valuable gift you ever give them -- it just might take a few decades before they realize it.

Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy

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