Teaching Your Kids About Money Part 2

Let's say your child just came into a big chunk of change. Perhaps he or she received it for graduation, as a holiday gift, in celebration of a major birthday, in recognition of a religious rite of passage, or because their parents or grandparents have decided that it's time to learn how to handle more than a few bucks at a time.

Or, for the sake of simplicity, let's just say it came from their favorite aunt. Dear auntie has decided to give your child, little Susie, a check for $2,000. No, she's not nuts, she just likes litte Susie. (All those "Yes, Ma'ams" and "Thank you, Ma'ams" have finally paid off.)

So, what is your child going to do with that cash? One option is to hit the mall running — spend it on new clothes, electronic games, sports equipment, and more. In short, have a ball.

Two grand can buy a lot of fun. Little Susie could be living large for a couple of months, even longer. This unexpected lump sum is called a windfall, and that's what many people would do with it, spend the cash like it was burning a hole in their pockets.

However, why not consider another strategy for your child's newfound wealth? This is an option that can potentially profit them for a lifetime, not just a few weeks or months.

Put that money to work for little Susie. Think of it as seed money. Let's say you "planted" that money in an investment where it earned a good return.

Let's say it grows at a rate of 6%. This means that, at the end of one year, your child's money would grow from $2,000 to $2,120. That's an extra $120.

Big deal, Susie may think. What's $120? Let's put it in perspective. If little Susie gets an allowance of $10 a week, that's 12 weeks worth of allowance you've generated. Or if your child works a part-time job and earns $30 a week, the "seed" money has earned them a month's worth of income — and he or she didn't have to cut one lawn, flip one burger or put up with one thinks-he-knows-it-all boss. Your child has their your money working for them!

Best of all, even if you took the profit, that $120, and spent it, your kid would still have the initial $2,000. But let's not stop there. Let's further say that you kept all that money working. By the end of year two — assuming the same 6% rate of return — the money would now total $2,247.20. Thanks to compound interest — which earns interest on interest — your child has "earned" nearly $250.

Not bad for just sitting back with your arms crossed. Let it sit for 10 years and it has the potential to nearly double, growing to $3,581.70, generating a profit of $1,581.70. (By the way, if you squeeze out another two percentage points, so your money grows at an average rate of 8%, you will have turned your initial $2,000 into $4,237.89 after 10 years. That's because the higher your rate of return, the larger your initial money grows.)

This, by the way, is how many wealthy people get to be wealthy people. But remember, as with all investments it is possible to lose money as well.

Okay, now let's be realistic. Your child needs to have some fun, right? Accumulating money for its own sake is boring. So, when does little Susie get to spend at least some of her money? Here's one smart-money strategy: Why not take half of your child's profit every year for fun, leaving the rest to work for them? That way, the money has the potential to grow, but your child also get to spend some of it.

For example, take $60 — that's half the first year's profit of $120 — and use it to buy something special, such as holiday gifts for your family or a new gotta-have gizmo for your child. Keep the rest slaving away for you. At the end of the second year, you will have $2,183.60. Once again, if you take half the profit above the original $2,000 gift, that gives you $91.80 to spend. After year three, you will have $108.66 pocket money, and so on.

Keep doing this year after year and... well, you get the picture. So, now you know one good way to build wealth for your kids. Your big challenge now is to just figure out how to get little Susie's aunt to give her that money to get started.