Warren Schmidt* leans back in his chair and smiles. There’s a bookshelf behind him. It’s stuffed with books about business and education. The 69-year old retired teacher lives in East Aurora, New York. He has three adult children.
“My wife and I had to be really careful with money when the kids were growing up,” he says. “With three mouths to feed and college educations to pay for, we really had to scrimp.”
Most parents can relate. Raising children isn’t cheap. In many cases, parents continue to shell out money after their kids have left the nest. It can be tough to say no when they ask for financial help.
In 2015, Merrill Lynch published Family and Retirement: The Elephant In The Room. In a survey of 5,415 American respondents, the firm found that half of pre-retirees over the age of 50 would make financial sacrifices to help a family member. Sixty percent said they would retire later. Forty percent said they would return to work if a child or a family member needed money.
But research conducted by the late Thomas Stanley showed that financial handouts usually do more harm than good. He studied a broad cross section of educated professionals in their 40s and 50s. He categorized them by vocation. Then he split them into two groups: those who had received financial assistance from their parents and those who hadn’t. Such assistance included cash gifts, help paying off loans, help buying a car, or help with a down payment on a home.
Those who had received help had less wealth during their peak earning years than those who had not received financial help. For example, accountants who received financial help from their parents were 43 percent less wealthy than accountants who didn’t receive handouts.
Thomas Stanley wrote, “The more dollars adult children receive, the fewer dollars they accumulate, while those who are given fewer dollars accumulate more.”
That makes sense to Warren Schmidt. He knew how to make life easier for himself and for his kids. “I made sure my kids earned their own money from a really young age. We used the power of compound interest so I wouldn’t have to keep writing them checks when they got older.”
His daughter, Julie, remembers when they opened her account. “I started to invest in a Roth IRA when I was 13 years old,” she says. “I was the nerd who walked around the neighborhood with a giant sign that said I was available for babysitting. I earned $5 a week for my allowance and my grandmother gave me a check on my birthday for an amount that equaled my age. But other than that, I had to earn my own money.”
Julie is now 37 years old. She teaches 6th grade at an international school in Malaysia. For most of her career, she didn’t earn more than $40,000 a year.
According to 2013 data provided by the Current Population Survey, in the Annual Social and Economic Supplement, Julie’s salary was in the 46thth percentile for American workers her age. In other words, more than half of Americans her age made more money.
But income isn’t everything. According to the May 2015Employee Benefit Research Institute Report, the median IRA balance for woman between 35 and 39 years of age was $12,857 in 2013. Julie has almost $300,000.
Many Americans, however, also own a home. Many have money in employer sponsored retirement plans. Julie doesn’t have either. None of her employers offered a 401(k). But the single teacher’s net worth is still seven times higher than the typical household led by someone her age. Even more remarkable, she recently took two years off to travel the world. She was spending money then–not saving it.
Her two siblings have also done well. That’s because they had time to grow their money. Warren Schmidt knew what he was doing.
Compare three scenarios. A girl named Samantha opens a Roth IRA when she’s 13 years old. She adds $50 a month ($600 a year) for nine years. After that, she adds $3,360 a year from age 22 to age 60. In total, she would have saved $133,080. But if Samantha earned a compound annual return of 8.5 percent she would have $1,093,479 by the time she turned 60 years old.
Compare that to a boy named Tony. He starts to invest $8,000 a year when he turns 35. He maxes out his annual IRA contributions, adding $5,500 a year. He adds an extra $2,500 a year into a taxable account. At age 50, the IRS allows him to add $6,500 a year to his IRA. He adds an additional $1,500 a year to his taxable account until he’s 60 years old. In total, he would have saved $200,000. That’s a lot more money than Samantha would have added. But by age 60, Tony would have less. If he earned the same rate of return, his portfolio would have grown to just $682,836.
Compare that to a girl named Lisa. She starts to save $15,000 a year at age 45. She deposits $5,500 a year into her IRA and $9,500 a year into a taxable account. At age 50, she bumps her IRA contributions to $6,500 a year. She also invests $8,500 per year in a taxable account. In total, she saves $220,000. But when she turns 60, if she earned the same return, she would have just $459,480.
Invest Early. Invest Less. Grow More Wealth.
Life is much easier for those who invest early. They can save a lot less, yet build more wealth.
“Every parent should try to get their children to invest their own money when they’re young,” says Warren Schmidt. “It doesn’t matter whether the money comes from delivering newspapers, babysitting, or any other part-time job. They should put their own savings into a Roth IRA. They can let compound interest do the rest.”
He says investors should keep things simple. “Stay away from individual stocks. Invest in a portfolio of low-cost index funds.”
Parents who want the best for their children–and the best for themselves–could learn a lot from Warren Schmidt.
(*I have changed the names and some of the non-financial details to protect identities.)
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.