Many parents who want their children to understand investing use a teaching method related to active stock picking. They give the kids real or hypothetical dollars, and invest in individual stocks, like Walt Disney or Nintendo, Electronic Arts or Nike—something the kids relate to.
Then they keep track as prices rise and fall. It's an engaging game, as is the one where students in a classroom compete to see which person can build the best-performing portfolio. But if you believe in passive investing strategies, these lessons skip some of the most important financial concepts: save regularly; avoid high fees; invest not to win, but to reach your goals; and try to take the least risk possible.
CNBC recently spoke with John C. "Jack" Bogle, legendary founder of The Vanguard Group, and president of Vanguard's Bogle Financial Markets Research Center, for ideas about how to teach kids about passive investing.
Stock investing has fallen to record lows since 2009—only 52 percent of Americans own stock, including through retirement plans, according to a recent Gallup poll. The confidence and knowledge to invest is a critical gift to give your children. Bogle provided some pointers on how to overcome the fears, doubts and temptations that might push you off the steady path required of passive investors.
1. What did you want most as a kid and how did you get it?
When Bogle was about 16, he used the money he earned working over the summer at the Bay Head, N.J., post office to buy an expensive imported English bike. The Raleigh cost $30, used, and had an enclosed chain case. The last meant there was no risk his pants legs would get caught, though keeping the chain oiled was a pain.
"It was a constant trouble but in any event I had a bike that I liked," he said. "When I was a kid, you saved and saved and then got what you wanted."
(Bogle hasn't shared that story with his grandkids, yet, though it's one he says illustrates the value of saving for what you want, and he might get to it yet).
The way he showed his own kids the value of saving was a little different, by necessity. His kids weren't growing up with limited means.
(Read more: Training your brain to be a Warren Buffett)
For each of his six children, Bogle started investment accounts for their college educations when they were young. When they didn't need the money for college, he made the money available to them to purchase their first homes. Some used it for their first home purchases. "They learned the value of putting money away in advance," he said. "Sometimes I say, 'I feel badly that you're not growing up with all the advantages I had.' It was nose to the grindstone, winter and summer. It's hard. But I always loved it."
2. No more than you (and they) are comfortable with
Aside from his oldest son, now a hedge fund manager, Bogle's children did not display much interest in investing. Bogle never forced the conversation on them.
You have to find the right way to communicate with each child, depending on his or her level of interest, Bogle said, and find a way that feels comfortable for you.
For each of his 12 grandchildren, who range in age from their late teens to their late 20s, Bogle regularly buys shares in the Vanguard Balanced Index Fund (VBINX), comprising about 60 percent of U.S. stocks and 40 percent of U.S. taxable bonds.
"We have a little sit down briefly at year-end," he said, where he shares how the investments in their names are doing.
(Read more: Donate to charity, or dump Exxon Mobil shares?)
As for the sum of what is coming to them in the end, Bogle feels no compunction to share it with them. This is just how he likes to handle it, but he said he has no particular opinion about whether more information would be better.
"For me, the best approach is no information about how much money is there. My executor can explain it to them."
3. The magic of compounding returns made simple
Bogle didn't do this with his own children, but he does think it's a good idea to pull out a $10 bill—or "two fivers," as he said—to show how compound interest works over time. A $10 investment will double just about every 10 years.
Another, slightly more complicated way to think about compounding: that $10 investment will spin off a 70-cent return, if it is earning 7 percent a year. In the 11th year, the accumulated interest will be larger than $10. That also will be the first year that the pooled interest produces more interest than the principle. That's the essential lesson, Bogle said: Saving over time is productive. After 30 years, the initial $10 investment will be worth more than $75, even if you never add to it.
4. An index fund is a teaching tool
Buy shares in an index fund when your child is in his or her mid-teens, ideally with a small amount of money that the child has saved. This a good moment to talk about what an index fund is, and to compare the fees on an index fund with the fees on actively managed funds.
Just as important, as the years roll on through college, your son or daughter can watch as the fund gains or loses value. The stakes are low at this point, so there will be little incentive to yank the money out. By the time your son or daughter is filling out the paperwork for their first 401(k) or IRA, they will have internalized the lesson of patience.
(Read more: Why retirement saving is getting harder)
5. Doubts are part of the process
It's incredibly difficult to stick to a passive strategy when, as in 2008-2009, the world is caving in. Being passive requires moving counter to the herd: selling when everyone else is buying and buying when everyone else is selling.
Surprisingly, Bogle, the father of the index fund, said he gets scared, too, and sometimes doubts the wisdom of his approach. "Every year, I think I could do better with my investments than I am. Then you get a swing in the market and I think, 'maybe I'm not as dumb as I thought I was,' " he said.
6. Live up to their expectations
The most important element, Bogle suggested—and this brings us back to the Raleigh bike and sharing your financial values—is that parents need to do as they say. Investing in index funds is part of a larger approach to your financial life.
If you preach savings and thrift while you borrow and spend, your kids will notice. If you live frugally and show your children how to delay gratification, they will most likely bring that approach to their investing lives, too.
That is probably why, Bogle said, his own children and grandchildren—the ones whose investing lives he is privy to, anyway—follow his strategies to a T, despite the fact that he was never heavy-handed in teaching it to them.
"I'm not sure you need to talk about it that much. (Kids) are really smart and really observant," Bogle said. "You live up to their expectations, or you don't."
—By Elizabeth MacBride, Special to CNBC.com.
