how to explain to a hard headed 18 year old

[disneysteve]

I do not understand a 401k at all. I have tried reading online about it but it is not very helpful. My basic understanding is that you are buying stocks.

Not at all. I like to use the analogy that a 401k or an IRA or Roth is just a basket. What you put into the basket can vary quite a bit. With an IRA/Roth, the choices are virtually unlimited. With a 401k, the options are limited to what the company chooses to offer, but there are generally the same types of things - a money market, a variety of stock funds (large, mid, small companies, domestic and foreign), bond funds, maybe target-date retirement funds, perhaps a real estate fund and/or other sector funds (gold, commodities, etc.) and probably company stock. You get to pick how your contributions get divided and which investments you put in your basket. You can be very aggressive, very conservative or somewhere in between.

I'd suggest OP try to get her daughter to start small and ultra-conservative. Sign up for a small contribution, even if it isn't enough to get the full match, just to have her get her feet wet. Although she would benefit greatly from going in full force and being aggressive, she isn't ready for that. Let her put 2 or 3% of her salary in for now to see how it works and see how it grows. Baby steps. If she does that, you can talk to her about gradually upping her contribution, maybe when she gets her first raise. She's young.

[jIM_Ohio]

I would not steer someone towards cash based investments just to get them started, TQM- totak quality management- when you do something do it right. BUY LOW. I might have them invest 25% into equities and 75% into cash, making sure the equity fund paid dividends, then comparing returns over short time periods (3 mo/1 yr/3 yr) to show how investing works. You don't learn anything on the sidelines.

after 3 months do 50-50 and go from there with asset allocation learning.

[maat55]

MAAT55,
but isn't that not true right now? How do you explain to a teenager that if she is patient the market MIGHT get better and give her more money than she put in. There is no guarantee right? I have heard for awhile now that the market will get better and yet I keep hearing the words, and the numbers dropped again today. I personally am concerned as well. By no means do I have an issue with anyone who has a 401K, I just don't think it is for me. Basically the stock market is a gamble.

Disney == I see where you are going with what you are telling her. Is that an area that is safe? or can it lose money too?

I would hope that the company investment choices include a MMA or cash equivalent. I get where your coming from, we just have to have faith that normality will return.

[whitestripe]

well, i am really sorry because i am not going to be any help for what you want lol. i am 21, and i live in australia. even though the government contributes $1.50 for every dollar that you put into superannuation, i will not be putting any money in this year.
why would you put money in with the amount of risk there is in the market right now? i just don't see the point.
superannuation is going down the toilet. in my opinion i feel safer putting money in a savings account. the money is there, and it's mine. it won't disappear. when the financial market is stronger and rates are on the increase, THEN you might want to argue with your 18 year old again.

[cptacek]

well, i am really sorry because i am not going to be any help for what you want lol. i am 21, and i live in australia. even though the government contributes $1.50 for every dollar that you put into superannuation, i will not be putting any money in this year.
why would you put money in with the amount of risk there is in the market right now? i just don't see the point.
superannuation is going down the toilet. in my opinion i feel safer putting money in a savings account. the money is there, and it's mine. it won't disappear. when the financial market is stronger and rates are on the increase, THEN you might want to argue with your 18 year old again.

So you put in $1 and the government puts in $1.50. You put in $1 and you end up with $2.50. You get an immediate 150% return on your money!!! Where else can you get that? You would rather get a guaranteed 3% in a savings account vs a GUARANTEED 150%?

Are you sure that there isn't a money market account or a "savings account" that can be categorized as superannuation so you can get that $1.50 match? There has to be some way to put money in a "holding area" so you can buy stocks at a later date...so just put the money in this "holding area" until you are comfortable with buying back in!

[jIM_Ohio]

I would givwe two examples. One is compounding and one is taxes.

Two people, both age 18 are presented with choices. Person A contributes $5000 per year to 401k and gets a $2500 match, Person B waits 10 years and does the same for 20 years.

At age 48, which one has more money? Person A which invested $50,000 and had it invested for 30 years, or Person B which invested $100,000 for 20 years.

Answer- it's not even close. Person A will have DOUBLE what p[erson B does with investing 50% less. I have a spreadsheet I can plug numbers in, but not on this PC.

Taxes- sane situation, I would point out that a salary of 25k investing $5000 pre-tax saves around $750 in taxes now, so it's only about $190 being lost per month, maybe $150 depending on state.

I have my spreadsheets now...

here are numbers
I used a 7% return in both examples.

person A puts in $5000 of a 25k salary (25k is $12.50/hr for 2000 hours) with a 50% match ($2500). At age 28 person A has $126k in 401k from $50,000 in contributions (another $25000 contributed from employer).

Person B at age 28 has nothing.
Person A without contributing another dime has $490k at age 48 and clears $1 M around age 59.

Person B starts 401k with $5000 contributions and $2500 match at age 28. They continue for 20 years (age 48). At age 48 they have 360k. They invested $100k to get a $50k match and still have $130k less than person A.

Summary age 48:
Person A contributed $50,000 and has $490k- nearly a 10X return (1000%).
Person B contributed $100,000 and has $360k- a 3.6X return.

The biggest factor a person has to their return is giving themselves TIME.

If person A kept up the $5000 contributions thru age 48 (with same 50% match) they would have 819k at age 48 on $150k of contributions.

Once a person is in the habit of saving, good things happen.


TAXES:

Have your daughter ask any of the co-workers to give her tax advice and tell her what everything is on the paycheck- the percentages and what the different things are (FICA-medicare-State tax-Federal tax) and how each are calculated. Ask her which of those the employer matches (medicare and FICA/SS)

25k salary
6.2% SS/FICA=$1550
1.45% medicare=$362.50
Fed tax (assuming single, no exemption can be claimed)- $3332.50 (math is [$25,000-8,350]*15%+$835)
State tax (Ohio would be $1114.25).

Take home is $18,640.75 in above example with nearly $7000 paid in taxes. This is $1553/month

Put $5000 into 401k (20% of above income)
FICA is still $1550
medicare is still $362.50
$5000 is put into 401k
Fed tax is $2582.50 (math is [$20,000-8,350]*15%+$835).
(**401k cost $5000 and saved $800 in taxes**)
Ohio Tax would be $928.75 ($200 savings)

Yearly take home is $14576

Take home would be $1215/month.

$5000 is $400/month going in but only costs $300/month in take home because of taxes.

Add in that the $2500 match is there and she has more money, it's just in a tax shelter.


If she needed more incentive, explain how savings needs to be a habit and LBYM needs to be a habit. Create the habit with a small percentage (maybe 6-10%) and go from there.

[simpletron]

if she won't listen to the logical arguements(i like jim's the best ^) then go with a old fashion bribe. offer to cover her losses for the first year or two. losses would means she loses more than she contributed then you'll make up the difference aka she puts in 100, the match is 50 and the end value is 90 then you'll paid her 10. if her company has a good match then more than likely your daughter won't lose more than the match even in 100% stocks over the first year or two. so she can't lose money(probably will make it), starts build a habit of saving/investing, and it is little risk to you, assuming the company has a good match.

how little is the risk you might ask. I opened another international fund last november in my 401k. the fund is down 58% since I started investing in it. I have contributed 2604.74 and the current market value is 1738.08. if your daughter had a 50% match and had the same performance then you would owe her nothing because she would have still made $1.59.

[jIM_Ohio]

if she won't listen to the logical arguements(i like jim's the best ^) then go with a old fashion bribe. offer to cover her losses for the first year or two. losses would means she loses more than she contributed then you'll make up the difference aka she puts in 100, the match is 50 and the end value is 90 then you'll paid her 10. if her company has a good match then more than likely your daughter won't lose more than the match even in 100% stocks over the first year or two. so she can't lose money(probably will make it), starts build a habit of saving/investing, and it is little risk to you, assuming the company has a good match.

how little is the risk you might ask. I opened another international fund last november in my 401k. the fund is down 58% since I started investing in it. I have contributed 2604.74 and the current market value is 1738.08. if your daughter had a 50% match and had the same performance then you would owe her nothing because she would have still made $1.59.

If match is 50%, a 33% loss would be break even.

[simpletron]

there is dollar cost averaging at work here. I didn't invest all of the money in november, but in fairly equal amounts every two weeks for the past year. obviously the money I invested 1.5 weeks ago is not down 33%(down .5%), but the money invested 1 year ago is down over 50%.

2604.74*.66666666= 1736.49

added:

there are a reasons to only to do it for the first year or two:
1. because of dollar cost averaging and the relatively short time it is unlikely for losses to over power a good match.
2. you only need to get her started, once she is off and running, she probably continue on her own.
3. to get her started, you need to counteract her fear of losing money like her friends. in this case she can't lose money.

basically it is just a dirty trick to play, but it will probably work if logic doesn't. my fear with this plan is in the unlikely event she does lose more than the match, it would only comfirm her fear and she would likely be turned away of investing for an extended period of time. but I really doubt the stock market will fall another 50% or even 33%.

[irmanator]

wow this took off, i will continue to work with her a little at a time. but who knows i never saw such a stubborn child!!!

[mrpaseo]

I agree with the bribe approach, of course after all explanations. What you are doing with the bribe is giving her a fish, if you educate her you are teaching her to fish.

Here is what I suggest, if she still does not understand, then tell her you will pay her what she loses per pay period. It seems to me that she is worried about the money that she is losing out of pocket (Being 18 years old is all I am going on here). If her max 401k contribution is 75 dollars per month, offer to give her that money on her payday so she is not out any money. I would agree to do this for 12 months. After the 12 months you will have hard evidence to explain the benefits of the 401k.

During that year, she must agree to read what you tell her to, a carefully chosen book, or maybe a weekly sit down in front of this forum with threads that you chose. Maybe you can have a weekly discussion with her and any questions that come up, the two of you can post them and then readdress them the following week.

I would do all this in a contract that she must sign. If she defaults then she owes you the money back. Don't make it to painful, I would put the particulars such as not more than two hours per week tied up with this arrangement (Unless a mutual agreement), it will not be during her friend’s time, and there must be a mutual agreement to change a scheduled sit down (Assuming you go with the forums idea).

If you go with the book idea, you should schedule a required sit down time let’s say weekly or fortnight. You too must read the book. During this sit down you both discuss the topics in the chapters that you read. So, let's assume one chapter per week, you both read it, you both come together and discuss the material, and you figure out how it applies to your finances (At your age/position in life) and at her age (Just starting out). This will show her how the investments affect you and your current position and how much easier life would be if she started saving/investing now.

Ray

[prosper]

that it is in her best interest to sign up for 401k even though everyone at her job is complaining about what they are loseing? I have tried everything i can think of but she is not listening because, you know mom is stupid and her young friends are so much smarter.

I know how you feel. This actually applies to adults also. I have found out that sometimes it take a trusted third party to reiterate your thoughts in order for them to sink through to the intended person. My younger brother believes his college friends over me all the time. The latest subject that we have debated to date:full time college students DO NOT have to pay taxes. So far, i'm 56-0 against his friends.

[Investing First Steps]

Numbers don't mean anything to people who find comfort in spending instead of saving. People become very irrational. I don't really believe the stock market will do very well for a while to come but:

1.) Very few plans force you to invest solely in stocks.
2.) If you're getting any kind of match you're out of your mind not to take it. Even if you have to put the money in something you see as sub-optimal, it's hard to lose 33% if don't jump in all at once. (Even the 40% downturn we've seen recently was from very top to very bottom, so to have experienced all of that you would have had to put in at the top and take out at the bottom)

[Exile]

I used to be a strong advocate of 401(k)'s, but now I'm not so sure. I am a retiree who contributed regularly to this kind of plan while I was employed. But thanks to the meltdown, I've lost almost all the gains that I earned since I stopped working. (Fortunately, my principal is still intact) I'm still in the program and have redirected my balance from riskier investments into a fund with a "guaranteed interest rate" fund, which is supposedly safe but it's not FDIC insured. If and when bank IRA CD rates increase by another percentage point, I will transfer my funds there and get out of "securities" altogether.

Unless daughter's employer has a 401(k) plan that is matching and offers a bank CD plan as an investment option, I would advise her to open an IRA instead and stay away from 401(k)'s until the market stabilizes and is past the danger of a depression.

[mrpaseo]

To echo what Exile offered, I fully agree with contributing only up to the match, then I would highly recommend a ROTH IRA for the remaining retirement contribution. (Eventually moving into a diverse portfolio of ROTH IRAs)

Ray