Teach Your Kids the Meaning of a Financial Gift

It's Not Just Money, It's an Investment
Last year, one of our loyal Morningstar readers wrote to me about how he struggles to find the right words to use as he gives his children financial gifts. Many of you have also done well in life and wish to pass part of that nest egg on to your children.

I think the key is to emphasize that this gift represents more than just what it can buy today. It's like a seed that you can plant in the ground that will grow to feed many people in the future. It's hard to see that when you're younger and trying to make ends meet. But part of growing wiser over time is recognizing the difference between "money" and "an investment."

True, money buys things today, such as a Nintendo Wii or an iPhone. But 10 or 20 years from now, those things will have long lost their appeal. Just take a look around your attic, basement, or garage to see what I mean.

An investment, on the other hand, requires patience, the ability to delay gratification, and a little bit of know-how. As a parent (or grandparent), you can help set lifelong patterns of financial responsibility by showing your children how to invest their money wisely. So, when you first give money to your children, don't just write a check. Give them some guidance on what to do with that money and what to expect over time.

A Helping Hand for Youngsters
Let's say you want to gift $1,000 to each of your grandchildren. Instead of just handing each of them a check and watching them spend it or deposit it in a savings account for college, why not help them open an investment account?

Even $1,000 can buy a well-rounded mutual fund like  Vanguard STAR . If you had invested $10,000 in Vanguard STAR in 1995, you would have nearly $40,000 today. That's a annualized total return of 11%.

To help young children get their arms around what it means to be an investor, start by explaining the difference between a stock and a bond. A stock makes you an owner of a company. You have a vested interest in how that company performs over time. A bond, on the other hand, makes you a lender. You will be paid interest over time because of the initial investment you made.

Advice for More-Mature Children
Older children may need financial guidance of a different kind. Maybe it's time to talk to your kids about building core positions in their portfolios. If you've had success with using index funds for your core positions, tell the young people in your life about how low costs and patience have paid off over time. Clue them in on the secrets of investment success, like how to ride out pullbacks in the market, decide when to cut your losses, or know when to take profits on winners.

Offer to analyze their current holdings for them. If you have more time than they do, you can enter their portfolio in Portfolio Manager on Morningstar.com. That can give you (and them) some insight into the balance of their current holdings--by asset class, by style, by market cap, etc. Maybe you'll notice some "holes" in their investment lineup. For example, maybe they haven't bought an international-stock fund yet. Your holiday gift might include an initial position in  Dodge & Cox International Stock or in another one of Morningstar's international  Fund Analyst Picks.

Conclusion
An investment in your child's future through a financial gift can grow to help pay for an education, a first house, maybe even the start-up capital for a business. Help your children to see how much fun it is to watch an investment grow. Celebrate milestones--like when that investment doubles or reaches the target goal for something special.

Teaching your children about investing not only gives them the gift of financial wisdom, it gives you the gift of spending more time with the people you love doing something that will last far beyond today.

A version of this article appeared on November 30, 2006.