Building a Safety Net for your Children

img_0131Today the news is full of stories of children returning home to stay after college.  The recession certainly made it difficult for some to find jobs, but the recession has been over for a number of years, yet adult children are still sticking around.  In some cases perhaps parents may be making their homes a little too comfortable. With few rules, no expenses and no responsibility, who wouldn’t want to stay?  At some point it becomes enabling, which is a curse, not a blessing for the child.

But if you think about it, stepping out into the world with just the clothes on your back is pretty scary and very risky.  You have no room for error, since you have no safety net there to catch you if you lose a job or just have an unexpected expense.    Many families also don’t talk about money, which leaves young adults needing to figure things out for themselves with no training.  Unfortunately, many kids today seem to think they can step into their parent’s lifestyle immediately, not realizing all of the work and time it took for their parents to be where they are.  By starting children out early learning about saving and investing, and by giving them a little nest egg with which to start, you can dramatically reduce the chances that they will be knocking on your door, duffel bag in hand after college.  Without another safety net, Mom and Dad become the safety net by default.

Starting an investment fund can be very quick and easy, especially if you use index mutual funds.  If you start a fund about the time the kids are born, add to it as they get those checks from relatives early on, and then match their contributions once they start to earn their own money, you can build up a substantial fund by the time they leave the house.  This is money they can then use when they have the unexpected expenses that always occur instead of running up credit card debt.  It can also provide rent payments for a couple of months after a job loss.

The first step in building this safety net is to find a fund family with a low enough minimum to allow you to open the account using the free cash flow that you have.  I personally like Vanguard because their funds have very low expenses and the minimums for many of them are only a few  thousand dollars.

In selecting which fund to buy, you are looking for a fund that invests in a large number of stocks over a broad range of the market.  Good choices would be a largecap fund such as an S&P500 fund or a midcap or smallcap fund.  Selecting specific sector funds or ETFs is probably not a good idea since you want something you can hold for years rather than needing to move in and out of it, incurring capital gains taxes.

Once you have selected a fund, simply create a custodial account in the child’s name and send in a check.  As time passes, add extra money to the fund.  You should avoid the temptation to make many if any changes or move money from fund-to-fund or into and out of a fund.  You want to minimize expenses and taxes, plus you might be in cash right when the market makes a big move up if you try to time the markets.  Just let it grow with the economy.  If you need to do something, wait for dips and buy more shares.

Once the fund has grown large enough, you should consider selling part and using the proceeds to buy another fund in a different sector of the market.  For example, if you’ve amassed $15,000 in a large cap fund, you may want to sell half and buy a small cap fund with the proceeds.  This diversification will reduce the risk of losses and smooth out the fluctuations that occur.  In general, different sectors of the market do well at different times.

Note that capital gains and dividends will be tax-free below a threshold amount, but be sure to check with your accountant on what those minimums are in any given year.  They are generally less for investment income than earned income.  You may also need to file tax returns in some years if the income is large enough even when they haven’t made enough to pay taxes.  Payment of quarterly estimates may also be required.  Minimization of trading, and thereby the realization of gains, will delay the time at which you will need to start preparing tax returns for their accounts.

Once the child reaches 18, the money will be theirs (you have no say over this).  You therefore should be teaching them the importance of managing the money so that it grows by leaving the principle alone and just spending a portion of the interest/dividends.  You can perhaps let them spend a small portion of the profits, but allow the rest to be reinvested and grow the account, so that they can see that their income will increase each year this way.    Explain that if they start spending the principal, the income they can receive will decline and eventually the money will be all gone.  Also teach them along the way that the money is there to help them in emergencies, such as when the car breaks down, and not just for day-to-day expenses.  Talk about what would happen if they had an emergency but had no money available, versus what would happen if they keep money aside.  Explain that going into debt means that they will be working extra hours just to pay interest rather than getting money from investments without needing to work for it.

Even given the best advice. they may make mistakes while they are young and foolish.  Think about holding a bit of money back and giving it to them when they are a bit older.  In this way you can give them a second chance should they fail the first time.

By giving your children a nest egg with which to start their lives, you can help keep them out of debt, help them have a down payment for a house when they are ready, and be able to stay out on their own between jobs and other issues. You will also give them an extra source of income that they can use throughout their lives.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Is Your Child Picky about Clothes?

GarnetsAt the Clever Dude blog, Brock asks the question: What would you do if your son dislikes all of the clothes he gets as gifts?  She describes her son who is very picky about his clothing, even when they take him along to shop for clothes.  He often will say he’ll wear something in the stores, but then leave it on the hanger when he gets home and never wear it.  They keep all of the receipts, needing to take things back often.  They then worry about what to do when it is hard to take things back.  For example, when her mother, his grandmother, buys him two sweatshirts for Christmas to make sure he’ll have one he likes, but then needs to take both back and mail another one that he may or may not like.

Now I’m guessing that if he is this picky about clothing that they aren’t buying him Faded Glory clothes from Wal-Mart.  They are probably buying clothes at the specialty stores and spending as much on a shirt for him as I spend on a whole outfit.  I’m also guessing that with the friends he has chosen that the labels he wears matter a lot and he is competing with others on clothing.  This means his parents are probably spending a lot on clothing for him.  Even if they aren’t, if they need to spend several afternoons at the mall, first buying and then returning things, they are wasting a lot of time, and time is money.  (Actually, I’ve always been surprised that stores take things back unless there is something wrong with the item.  I guess they figure you’ll buy more while you’re there, so it makes up for all of their time taking things back and restocking.)

It sounds to me like the son has a bad case of ingratitude, a disease prevalent among many children today who are overindulged by their parents.  (I confess, after hearing my own children complain about having to go to really neat science museum yesterday — complete with rides — instead of being able to sit home that I may be guilty of inflicting he same disease on them in the area of zoos, museums, and science centers.)  It was only about five generations ago when many children valued any clothes that they had because they didn’t get a lot of them.  A pair of jeans had to last the season, or maybe a year or two, because they would only get a pair or two per year.  Getting a new pair of shoes in the fall might have been a big deal for many children.

Today many children are given all of the clothes they want and then some, to the point where they worry about their own “sense of style.”  They also don’t tend to take care of their clothes because they know mom and dad will just buy them more.  Tore up the new, $60 jeans?  Oh well.

Now I agree that children should have a primary say in what they wear after about the age of 8, when they stop wanting to wear a sweater with a pair of shorts to school in September.  But still, teaching children that clothes aren’t cheap and getting them to appreciate what they get, not to mention learning that they will have a limited amount of money for things and that there will be clothes they just won’t be able to afford will help them when they become adults and mommy and daddy aren’t there with the credit cards, is important.  So what’s the plan?

The Plan

How about giving them a fixed amount of money each month for clothing.  For a middle-class family, something like $50-$100 might be reasonable.  Also give them a list of requirements, like they need to have long pants and a jacket for the winters, formal clothes for church and events, and a rain coat and socks.  Then, give them a reasonable amount of time to shop for themselves with the understanding that you will not be returning to the store before the next scheduled shopping trip unless there is something physically wrong with the clothes.  They have money and they have opportunity.  You have done everything needed to be a good parent and clothe your children.

Give them the chance to fail.

Probably one of the toughest things to do as a parent is to see your children struggle and deal with adversity.  Yet it is very important for their development that they be allowed to feel a bit of emotional pain for their bad choices.  Realize that you’re letting them make bad choices in a controlled environment.  It will be more serious when they decide to have a party rather than save their money for the rent and they face eviction when they’re young adults.  Bad financial decisions come with consequences, and most financial hardships we face are a result of what we do or fail to do.

If they come home from the mall with nothing, roll the money for the month over to the next (or keep it) and let them wear their old clothes, even if they’re two sizes too small.  If they spend all of their money on one outfit because it is just “so cool,” let them show it off and wear it, again and again.  If they don’t like what they bought, they can wear it anyway or they can donate it, but they won’t get any more money for clothes until the next month.  If they’ve spent most of their money, they can also spend some time at the thrift store looking for replacements, which will teach them both that many people don’t have the ready access to clothes that they have and that clothing yourself need not cost a lot of money.  There will be tears and tantrums, but freedom comes with consequences, both good and bad.

Failure is how we learn to not fail in the future when the consequences are graver.  Some of the nicest people in the world are enablers, who think that they are helping someone, but really they’re allowing them to maintain a lifestyle that is unsustainable.  Giving in to your children’s demands when they are young creates entitled adults who will think Bernie Sanders is a great choice for President.  Your adult children need to learn to make enough money for rent and food and budget for these things.  They need to figure out how to pay for their own cell phone.  Propping them up by paying for their rent or their food so that they can live beyond their means will keep them from learning their financial limits and delay them from finding ways to make more money so that they can afford better things.  Starting out by learning how to budget money for clothing, and learning just how much clothes cost, is a good start.

So what do you think?  Please leave a comment – I’d love to hear from you!  Also, I’m happy to take your investing questions.   Please send to or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Buy Your Roof Before the Rainy Day

Ask SmallIvy

Most people are able to at least tread water financially.  They learn to cut coupons, get pizza a few nights instead of more expensive meals as take-out, and eat lunch at their desks a few days a week instead of going out every day.  No matter their income, they come to an equilibrium where they are spending the same amount each month as they are taking in.  They then use things like the “extra” paychecks a year – those months where you get 3 paychecks instead of two – or tax refunds to  buy luxuries like vacations and toys.

Still, most people get into debt and when that happens, they end up spending a lot of their money on interest instead of putting their whole paycheck toward things like retirement and college savings.  The reason they get into debt despite being able to handle the usual monthly expenses is the unusual events that cost a lot of money and seem to come up “suddenly.”  Since everything that comes in through salary goes out each month in expenses, they have no savings to take care of things like the new roof or the car repair.

This brings us to the next item in the list provided in 10 Dirt Simple Rules of Money Management, a series I hope my regular readers are enjoying and finding useful.   (Note, you can find all of the posts in this series by choosing Dirt Simple from the category list in the right sidebar.) Today we cover the sixth rule:

6.  Put money away until you can buy a new roof and a good used car for cash, then invest it in diversified mutual funds until you need the money.  Automate as much as possible.

Eventually you will need to replace your roof.  Eventually you’ll need a new air conditioner.  Eventually that car you’re driving will need to be replaced.  When these things happen, you can’t just cut back on expenses and start saving up the money needed at that point because the things are needed now, not five years from now.  You need to be putting money away each month as if you are making a car payment, a roof payment, or an air conditioner payment.  (Otherwise, you’ll end up taking out a loan to pay for these things and you will be making payments, with interest.)  These are things that should be in your cash-flow plan and you should be putting money aside for them each month.  Remember that it is more difficult to cut back on spending to save than it is to never have spent all of your paycheck in the first place.

So, right from the first paycheck, open a savings account that you call the “Home and Car Fund” or the “Big Items Fund” or maybe the “Murphy Repellent Fund” and start putting money away.  Just figure out the things you’ll need to replace, the approximate cost, and the number of years between replacements.  For example, your list may look like this:

Item Cost Replace In(years) Per Year Per Month
Car (4-year old) $10,000 5 $2,000 $167
Roof $10,000 20 $500 $42
Air Conditioner $5,000 15 $333 $28
Flooring $5,000 10 $500 $42
Lawn Mower $500 10 $50 $4
Refrigerator $2,000 12 $167 $14
Washer/dryer $1,000 12 $83 $7
    Totals $3,633 $303

So now to be ready for when the next disaster strikes, all you need to do is put away $303 per month (maybe round it up to $310) into a savings account.  Ideally you should do this as a direct deposit from your paycheck so that you will remember to do it.

Note that everything goes into the same account instead of putting money into a roof fund, a car fund, and so on.  This is the better approach since it helps you get ready for any one of the expenses happening in any given month that much faster.  If you were only putting $167 away in a car fund to be ready to replace your car in 5 years, but then the car died in 3 years, you wouldn’t have the money needed.  Because you’re putting away $303 a month, you’ll have the money you need to replace the car in two years and seven months if you needed to do so.  In this way you’re acting like your own insurance company where you put all of the money into one pot and then pay out “claims” as they come up.   The only thing to be careful of is taking out money before you really need it because the balance becomes large.  Remember that those expenses will come eventually and you’ll need the money when they do.

Of course, most of these things will not happen in any given month, so the balance in the account will build.  Eventually you will want to start to invest at least a portion of the money so that you can get a better return and not see money lost to inflation each year.  In fact, once the fund reaches a critical mass and is invested, it may sustain itself and you won’t even need to contribute anymore, leaving you free to save your money for other things like a vacation fund, increases in your retirement fund, home upgrades, or whatever else is important to you.   

When making the decision to start to invest, keep in mind that this is money that you need to have available when you need it.  You therefore cannot lock money up that you’ll need in the next few years away in things like individual stocks that will have unpredictable values from year-to-year.  I would therefore do the following:

1.  Keep the money in a savings account to start, then shift some of the money to 1 year CDs as the balance built up.

2.  Once the balance built to the point that I could do the biggest item on my list (in this case, replace the car or the roof), I would hold that amount in CDs and start to shift new monies into an index mutual fund.  I would probably pick a large-cap fund like an S&P500 fund or maybe a total market fund since the fluctuations for these funds would be less than that for small caps or other funds.  I might also consider REITS (real estate funds).  

3.  Once I got to the point that I had 150% of my largest purchase, I might start to shift a bit more into the mutual fund.  For example, I might keep enough for 50% of the purchase in bank CDs and the rest in the mutual fund.  The reason is that it is very unlikely that I would see more than a 50% drop in a mutual fund, so chances are very good that as long as I had 50% in a bank CD, I’d have enough in the mutual fund to cover the rest of the purchase.  Once the value of the fund exceeded about 15 times my annual contribution (about $55,000 for the case above), I might shift the money entirely into the index funds, but raise cash as needed for expenses that I knew were about to occur (see item 4. below).

4.  If I saw one of the purchases coming up in the next 2-3 years, I’d start shifting money to bank CDs, and reducing the term of those as needed to have the cash available when needed.  For example, if I knew that the roof would need to be replaced in 2-3 years, I’d start selling the mutual fund off at opportunistic times, such as after large run-ups in the market, to raise cash.  When I knew I was within a year of needing to replace the roof, I’d shift the money from 1-year CDs into perhaps 6-month or 3-month CDs, eventually just putting the money into a money market fund when I was starting to line up a contractor.

5.  I would keep contributing to the fund until the value of the fund was at least 30 times my yearly payment.  For example, if my payment were $3,633 as shown above, I would contribute until I had at least $110,000 in the fund.  After that, I would be reasonably assured that the fund would be able to sustain itself, with capital gains and dividends from my mutual funds replenishing money as it is spent on expenses.  If the balance dropped below that level, I would resume payments into the fund again to bring the balance back up.

Got an investing question?  Write to me at or leave a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.