Money Matters: How to Teach Your Kids About Spending, Saving and Financial Responsibility

VIDEO: Mellody Hobson ambushes kids on the street to test their financial knowledge.
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What do younger children know about money, and financial responsibility?

Not much, so it is up to parents to teach their kids about spending, saving and making sound financial decisions. These are skills that will be critical for them as they grow older.

Mellody Hobson, president of Ariel Investments, and "Good Morning America" personal finance contributor, appeared on the show to share tips for teaching children about how best to handle their money.

Q: How young should I start talking to my children about money matters?

A: Mellody says: For many parents, this is the last thing they want to do. A recent study found that parents are more prepared to talk to their children about sex, alcohol and drugs than they are to discuss finances.

But parents are urged to start financial literacy education with children who are as young as 5 years old. The conversation can go beyond coins and money, and be sure to put it in terms that the children will understand. Include toys, or ice cream, or other things that are familiar to them in the conversation.

Q: What's a good way to teach my child about interest?

A: Mellody says: Your credit card can be a great teaching tool. Every time you use it, talk to your child about how it works, and what you will owe at the end of the month. If you don't pay the bill in full, explain the concept of interest to your child. Have him or her sit next to you when you pay the bill, and allow the child to observe what you are doing. Showing your children your good financial habits will slowly build and reinforce their understanding of how important those habits are.

Q: How can I slip in lessons about good money habits on a more consistent basis?

A: Mellody says: You know how children love to give money to the cashier when there are out with you on a shopping trip? Take the shopping receipt and talk about how much their favorite cookies or toys would cost, but use allowance terms. Tell your child how many weeks' worth of his or her allowance would be required to purchase a certain item listed on the receipt.

Have your older children help you calculate the tip at a restaurant, or give them the money to pay the bill. The addition exercise will sharpen their math skills and make them part of a family financial decision, and it will also be fun for them. But, here's one big don't: Don't treat the ATM as though it's a game. Parents often let their children punch the keys when they go to an ATM. Don't do that. What you can do, though, is explain how the ATM works when you're there. Tell them that it's not free money. Let them know that you're taking money out of your own account, and that you worked very hard to put it there. Compare it to taking money out of a piggy bank.

Q: I've heard about the "family 401(k)." What is that?

A: Mellody says: Just as many companies match their employees' contributions to 401(k) savings plans, parents can kick in a matching contribution to money their children save. For every dollar of their allowance they put away in the bank, you can match it in some way, some percentage that you can afford. This will give children a real incentive to save. Having their own savings account, and getting monthly statements from the bank, can also be a good way to teach them about interest and compounding.

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