The great thing about banks is that you’ve probably already introduced your children to the basic concept. As soon as you gave them an allowance and provided them with a place to keep their money, they got exposure to what banks do with you acting as the banker. The trick now is explaining why they would want to keep their money in a real bank as opposed to their piggy bank.
First, start with a simple explanation of what a brick-and-mortar bank is: a place to store your money. They will probably already have an idea in place, having seen bank buildings around or read about “Gringotts” in the Harry Potter series (if only J. K. Rowling had thought to include “interest” on those gold coins, how easy my life would be). Tell them that just like their piggy banks, they can have an “account” at a bank where their money is kept. Same as a piggy bank, you can put money in or take it out. When they are young, you can open a custodial account for your child. The account will be in their name with the intention that it be used solely for their benefit, but as custodian you will have fiduciary responsibility.
If you choose to open a custodial account for your child, do your research on the best options available. Weigh elements like the convenience of having a local branch down the road with the interest rates offered or lower minimum balances that you might find elsewhere. I like having a brick-and-mortar bank branch to pop into, a place where I have personal relationships with the people who watch over my money. I want the same thing for my children. When they are old enough, you can take them to the bank and let them tour the building and meet the bankers. This might sound boring to you, but remember that children can get excited about outings like school field trips to the post office as long as it’s framed as an adventure. Show them the vault, the coin-counting and bill-counting machines, and the way a cash drawer works.
As important as children's piggy banks may seem to them, make sure that they understand that having a bank account is a bit more complicated. Explain that the account usually has to have a minimum amount of money in it. If she tries to take out more money than the minimum amount (or more than they have), their bank will charge them a penalty fee to be paid to the bank. She might also have maintenance fees attached to her account, which is paying the bank for having the account and for services attached to it. And at times there are fees to be paid should she chooses to close the account early.
The Magic of Interest
The key question then is why your children would want to put their money in a bank if it comes with all these costs and deprives them of the ability to touch and feel their own money. This is our first difficult concept: earning interest on money. Most of the financial education books I read jumped right into the mathematical reasoning behind compounding interest. A few of the experts tried to make the concept more accessible by using an illustrative anecdote or hypothetical you can share with your child. The classic example of compounding effects is the story of the emperor of China who wished to reward the inventor of chess. The inventor asks for one grain of rice for the first square on the chessboard, two for the second, four for the third, and so on, doubling the amount with every square. The emperor agrees, not realizing that by the time he gets to the sixty-fourth and final square, he will need to pay the inventor 18 million trillion grains of rice. The same idea can be applied to money sitting in a savings account, although sadly not usually to the same degree. The problem is, while I think this story is cool, my children are going to be pretty old before they stop wondering why the heck I’m talking about Chinese emperors and really grasp the message being illustrated.
I thought about this a lot and decided that maybe this is one of those times I can introduce a topic without having to get into the gritty details. To begin, I came up with the metaphor of a farmer who has a sunflower seed that he can either put in a jar or plant in the ground. If he keeps the seed in the jar, he will always just have the one seed. If he plants it in the ground, a sunflower plant will grow and he will have many seeds. Putting your money in a bank account follows the same concept. Keep a quarter in your piggy bank and you will have one quarter. Put it in a bank account and you will have a quarter and some pennies. Why this happens (interest) is maybe confusing and pretty boring if you are eight years old. So here is what I tell my children: it’s magic. No, really, I do. My goal is for my children to want to save money so their money can make more money for them—without them having to do anything. If I can get their habits on track early, then I’m okay waiting to explain each piece of why this works until they are old enough to be interested.
When they are in fact old enough to understand, you can explain to them that when they put their money in the bank, it doesn’t just sit there; the bankers are giving it to other people to use. This might sound scary—what if the people using the money don’t give it back? Explain that one of the benefits of using the bank is that the bank effectively guarantees you will get the money back. Even better, they give you some extra money as a payment for using yours. The people who used money from the bank had to pay a little to be able to borrow it. In other words, if you want to borrow money from the bank, you have to pay a fee. This is what we call interest.
The very best way to explain the concept of interest to children is through practical application, for example, offering them interest on their allowance savings. If you are struggling to find a good analogy for your child, try checking out the United States Securities and Exchanges Commission report on tips for teaching saving and investing. You might even choose to open an account for your child before they have enough money to warrant it. Maybe you want to start a savings account for her early on so she can practice investing later. Or maybe the thought of money sitting in a piggy bank doing nothing just drives you crazy. You can figure out creative ways to get your child an account without making them cash rich, or follow a interactive guide online such as that of CreditCards.com. I wanted my children’s savings to sit in a real account, so I went to a local community bank and opened savings accounts for them. The only problem was that the bank required a $1,000 deposit to be able to earn interest. I opened the accounts with $1,000 each from my own pocket, but $1,000 was way too much for any of my children to think they had—I’m not sure they can even count that high. I envisioned my young children discovering their status as thousandaires and suddenly had a vision of them in their thirties, living out of my basement.
So what did I do? Well, when we pay their allowance I take the “Savings” quarters and then transfer the amount to their bank accounts online, showing them how I do so. Then every month when their bank statements come, I painstakingly white out every line that contains references to their assets being more than $45.37. It sounds like a lot of effort, but laying a great foundation for interacting with banks later on makes it an easy price to pay. I’ve found that my children love getting mail, and it’s worth asking your bank to send printed statements every month—it’s a great way to remind your child that their money is working for them.