By Kiyosha Baird
Every child has the potential to become a self-made millionaire. Unleashing that potential can be done in three steps: earn, save, and invest. While not easy, these steps will lead your child to financial wealth over time.
Let’s dive in.
Earn
Money. How do you earn it?
The most common way to earn money is to get a job. Often, a kid’s first job is doing chores, through which they earn an allowance. However, what is less commonly emphasized is that there are two ways to earn money. Two roads, if you will. They are active and passive income.
What is Active Income?
Active income trades effort and time to make money. Doing chores and getting a job are examples of active income.
Active income is a great way catalyst, but not a finish line. Here’s why.
Imagine you pay your child $20 for doing their chores. When your child receives the money, what happens? They can spend it, turning $20 into $10. They can save it, keeping the $20. Or they can invest it, transforming $20 into $30. Self-made millionaires invest. They grow their money by turning it into passive income.
What is Passive Income?
Unlike active income, passive income is not tied to effort and benefits from time. Passive income is money earned from investments by creating or buying assets, something of value that makes money. Examples of assets may include stocks, bonds, businesses, intellectual property, and real estate. Investing isn’t just for grownups. There are special ways that kids can invest, too. More on this later.
Which Road Do Self-Made Millionaires Take?
It turns out that self-made millionaires do not take just one road to wealth, active or passive income. They take both. Turning their earnings from active income into passive income through investing.
That is the real meaning behind the three steps of earning, saving, and investing. It’s a way to turn active income into passive income and grow your child’s money. Cha-ching!
After your child has earned money, saving it will be their next priority on the pathway to millionaire status.
SAVE
Anyone can spend money. However, few can save money. Learning how to save money is essential for kids to become self-made millionaires.
How do you begin nurturing this skill in your child?
One of the best ways to learn to save is to practice budgeting.
How to Make A Budget
A budget is a tool. It allows your child to prioritize money so that they can have fun today, while preparing for tomorrow.
A great budget method for children is the 50/30/20 budget. Under this method, your income is allocated 80% to spending and 20% to saving. Here’s the breakdown:
- Spending: 50% Needs + 30% Wants
- Savings: 20%
So, if your child earned $1,000,
- $500 would be for needs, representing necessities like food, clothing etc,
- $300 would be for wants, representing optional costs like games, concert tickets, etc
- $200 would be for savings, the money set aside for future use.
Learning the 50/30/20 budget method will instill your child with good financial habits for life. Pro tip, older children can improve their budgeting skills by keeping an emergency fund, saving before spending, also known as paying yourself first, and automating savings through the bank.
Your child has a stockpile of money from saving. Now what? You don’t want that money just sitting in the bank earning zilch for interest. You want your money to work for your child. This brings us to our next topic, investing.
Invest
Before you begin investing, you may want to share a few considerations with your child to help prepare them for the risks and rewards of investing. One such consideration is determining your child’s financial readiness by calculating their net worth.
Calculate Your Child’s Net Worth
Net worth is a measure of personal wealth. Naturally, a millionaire is someone with a net worth of at least a million dollars. Self-made millionaires focus on growing their net worth.
How is Net Worth Calculated?
Net worth is calculated as total assets, everything your child owns, minus total liabilities, everything your child owes. Calculating net worth will get one of three results: negative, zero, or positive.
Let’s look at each of these.
If your child’s net worth is negative, they’re in debt. Their financial focus should be on paying down the debt to bring their net worth to zero before beginning to invest. While young children rarely have debt, this may not be the case for teens. Debt can arise through credit cards, buying a first car, or entering informal borrowing arrangements, such as borrowing money from mom and dad with the promise to repay.
If your child’s net worth is zero, their assets equal their liabilities. This means that if your child had to pay all their liabilities at this very moment, they would have no assets left over. That’s not good. At this stage, your child should focus on creating more financial capacity to start investing by reducing liabilities, maybe fewer lattes at Starbucks, or increasing assets, saving more money to buy more stock, to improve their net worth.
If your child’s net worth is positive, they are building wealth. Self-made millionaires operate on this level, focusing on maximizing net worth by increasing assets while keeping liabilities low. In other words, this is the level that is safest to begin investing.
Let’s say your child has cleared the net worth test and is ready to invest. To get started, they will need to establish their risk tolerance and have an adult open a custodial investment account.
How to Invest as a Kid
There are many different types of assets to invest in. Stocks. Bonds. Real Estate. And many more. However, each asset has its own unique fingerprint of risk and reward. That is why establishing risk tolerance is so important.
What is Risk Tolerance?
Risk tolerance is the amount of risk your child is willing to take when buying an asset. It usually has three levels: low, medium, and high, or conservative, moderate, and aggressive, respectively. For more insight on the level of risk and rewards of the most common investments, check out investing basics for kids.
Once your child has selected an asset type, it is time to buy it. For stocks and bonds, you’ll need a custodial account.
What is a Custodial Account?
A custodial account is an investment account owned by a child but managed by an adult or custodian until the child is 18 or 21. At that point, management transfers from the custodian to the child. An adult can open the account through a brokerage company.
Like most things, custodial accounts have advantages and disadvantages. You can learn more about these here.
Conclusion
Becoming a self-made millionaire is not just a dream. It is doable by following three steps: earn, save, and invest. These three steps enable your child to turn active income into passive income and increase their savings through budgeting, which allows them to grow their net worth over time.
Take a small step to get your child started on the road to wealth. Consider starting an allowance, making a budget together, or opening a custodial account today.