There are many ways children can be exposed to investing at an early age when they are most fungible. It is important to teach children how to save more and spend less. During the pandemic, the US personal savings rate has been well above average at 23.2% in May compared to 7.5% at the end of last year. However, the means to make any interest income on the increased saving is virtually impossible. According to the FDIC, the national average rate on savings rates stands at a paltry 0.06% APY (annual percentage yield) for all deposits. That’s chump change. With the Federal Reserve keeping interest rates near zero–possibly to 2022–interest income will stay low.
However, saving more paves the way to investing more and building wealth, particularly if you start in your twenties. The longer the time to invest, the greater the growth potential.
Why Investing Early Matters?
You should start investing early in life so as to have as long time horizon as possible for these reasons:
- Leverage the power of compound interest (interest on interest) earned on your initial investment for significant returns in your retirement and investment accounts.
- Take on greater risks when you are young and able to absorb the bumps and bruises of downturns.
- Motivate yourself to save more, spend less so that you can grow wealth.
Investing is a viable means to accumulate wealth and enjoy financial comforts. The earlier you start to save money for investing purposes, the better. Parents should begin talking to their kids about how to handle money when feasible, exposing them to developing good financial habits.
9 Ways To Talk To Your Kids:
1. Start Early Lessons On Saving and Investing
Conversations with your kids about anything sensitive can be awkward, especially about money. According to a 2018 T. Rowe Price survey, 66% of parents have some reluctance to discuss money matters with their children. Only 21% of the kids recall their parents speaking about money at least once a week.
Speaking to children about investing at an early age takes some of the mystique out of it for them. For parents, it is more comfortable to talk about savings, giving them a head start in math. Explain how the bank holds money for people in savings accounts and can earn money. Use an example of putting $100 in the bank ( refer to a piggy bank) that can earn 1% a year paid by the bank and grow the amount to $101. Another bank may pay a higher interest rate of 5% and grow that same $100 into $105 in one year. Nowadays, interest rates are so low that investing makes even more sense.
Picking Familiar Names They Know
Savings comes about when you spend less than you earn. Investing is taking some of your savings and putting it to work so it makes even more money. There are many kinds of investments you can make. We will stick to stocks here. Explain to your kids that when you buy a stock such as Nike, you own a piece of that company. You can grow your original investment into a bigger amount over time. Investing over the long term benefits from compounding, a magic concept that can be taught through the following book.
2. A Lesson in Compound Interest From A Folktale
Compounding interest is a powerful concept when you have a long horizon by investing early discussed here. It occurs when interest or gains are added to the initial investment (or principal) providing substantial gains. It can lead to exponential growth over long periods of time. While it is a complex idea, young children can grasp it in the form of a story as my son, Tyler did.
When Tyler was in the second grade, he came home from school one day, carrying a beautifully illustrated book, “One Grain of Rice: A Mathematical Folktale” by Demi. He was carrying this large book with a reverence that I hoped would last longer given my love of books. Tyler asked us to read the story. It is a delightful Indian folktale about Rani, a clever young girl who outsmarts the greedy king. When the selfish raj offers to reward her, she asks for one grain of rice, doubled each day for 30 days. Rani uses the surprising power of compounding to snatch 536,870,912 grains to feed her hungry villagers.
Tyler’s Stock Pick
Tyler, a teenager now, actually reminded me the other day about this story when I was finishing a recent post on the magic of compounding. He recalled that it spurred his interest in numbers and later, in stock investing. When Tyler was about 8 or 9 years old, he would sit with me as I bought stocks. As a quiet boy, I encouraged him to talk:
Mom: What stock so should we buy today?
Mom: Why Costco?
Tyler: It was very busy in the store yesterday. You complained to Dad that you spent more than you expected when we were there. Maybe everyone else did the same thing!
So I bought Costco shares at around $90 per share and it turned out to be a profitable investment. Of course, not all of his “recommendations” have been as good. Tyler was in a stock market game club in high school and has shown interest in learning how to invest through the years.
3. Stock Market Games As A Learning Tool
Parents can explore investing basics with their kids without losing money through simulated stock market games. These games are a great way to practice before becoming an investor in the real world. By simulating the market in real-time, the player can experience gains and losses. As such, they can be effective learning tools. Investing can be daunting for the experienced investor, let alone for those who are just starting out. Virtual games are free, fun, readily available and user-friendly. They offer participants a faster learning curve to build investment skills and better financial habits.
Our kids are digital natives and are particularly attracted to simulations. They often prefer video and simulated games to traditional modes of learning. However, the virtual games are user-friendly and can appeal to anyone, even digital immigrants. I have experimented with several games. As a result, I have settled on Market Watch Virtual Stock Exchange by Dow Jones for my college students as well as my kids at home. You can learn more on How Stock Market Games Can Teach Investing here.
Most stock market game sites have many articles and videos to help new investors to understand differences in risk/reward trade-offs and measure your own tolerance to make more risky purchases. Feeling gains and losses are real enough and allows you to pivot in different ways.
4. Valuable Lessons Are Everywhere
There are valuable lessons that young people can learn about investing. Being patient about investing can be a virtue. There is a tendency for beginners and even more experienced investors to start trading their stocks, particularly as markets get volatile. This usually ends up as a disaster if sold stocks of good companies that dipped temporarily. Teach them that stocks don’t always go up or down in a straight line. Sometimes there is a market downturn where virtually all stocks decline but the more favorable stocks may come back sooner.
As your children get older, they can learn about investing in different and fun ways. My kids watched Shark Tank before I did and enjoyed watching which products and services were hits with the investing sharks. I encourage my college students to watch Jim Cramer on Mad Money, with his strong focus on individual investing. When my daughter, Alex, was younger, she watched Cramer for his zaniness but told me he ranted too much for her. She now will watch parts of the show to learn more about stock investing and his interviews with CEOs of companies she is aware of.
5. Diversifying Portfolios Reduces Risk And Growth
As you engage with your kids in encouraging them to invest money into stocks or other investments, they need to be aware of the risks and rewards. Generally, investing in stocks tend to carry higher risk and higher returns than putting money into a savings account or into bonds. Diversifying their portfolio is a key lesson on how to lessen those risks. Tell them about what kind of stocks you have and how each stock represents a different kind of business. Use company names they are familiar with such as Apple, Disney, McDonald’s, and Facebook.
My son Tyler played a simulated game in a stock market club in middle school. He had put all of his money in one stock–Amazon–when it was rising significantly. He was so excited that he was doing the best in the club. Then Amazon reported quarterly results that missed analyst expectations. They also announced a rise in capital spending for their data business. Amazon shares crashed and became “dead money,” a term investors use to mean that the stock’s performance will drag.
For Tyler, it was a learning experience about why diversification is important in your portfolio. Concentrating all your money in one stock is a risky strategy. It is not good to put all your eggs in one basket. I told him it is always best to put your money into a group of 5-10 stocks that are different from each other. This post addresses tips on diversifying your portfolio.
6. Bonding Experience For The Family
The T. Rowe Price study found the effectiveness of financial education in the home or school were both falling short. As parents, we are often role models for them so take advantage of their impressionable years to guide them. Encourage your children’s active participation in stocks by setting up an investment account where they can make decisions on what they want to buy. Ask them to give you their reasons.
Clearly, parents can enlighten their kids regarding their own attitudes and investing strategies. Investing is a great way for families to bond together as young kids gain confidence through your experience. It is a cool way to speak to your kids about your overall values. A big area of investing is in socially responsible companies that have an aspect of social change embedded in their mission. Important issues that these stocks or funds address relate to the environment, sustainable food, energy-efficiencies, income equality, and such.
7. Be Honest With Your Mistakes
We all wish we did everything well. The truth is that we all make mistakes, especially when investing. I share my investing blunders with my kids all the time. When I first began buying stocks, I often ditched good stocks that had gone down quickly and came back just as fast. Day trading is speculation rather than investing and is more costly due to fees and tax implications. Over time, I learned to do more research and be more patient.
Among our bigger mistakes that I often share with our kids is buying a lot of art and antiques at probably peak prices. This happened before we had kids. I was limited by my Wall Street position from investing because of purchase restrictions. Frankly, I developed the bug to buy 18th century Federal furniture and other collectibles. This is not a category for investing I would recommend to anyone unless for aesthetics as it won’t contribute to retirement savings.
8. Opening Investment Accounts For Your Children
There are several ways you can get your children started on their path to investing and financial independence. Choices vary based on whether they are a minor or have reached the age of majority, usually at age 18 in most states. Consider if you are setting this up for your children to have the ability to make choices or as a passive account where you will use low-cost index funds or exchange-traded funds (ETFs) where they may be immediately invested in a diversified basket of stocks.
A Guardian Account
If your child is underage, a guardian account would be established in the child’s name and in the parent (s) or guardian’s name. The account is owned by the parent(s) who has legal title, owns the assets in the account, and is responsible for any liabilities such as fees and income taxes. At this age, the child has no legal ownership until it becomes a joint account at the time he or she reaches the age of majority. Depending on your goals for such an account, let your child make some of the buying decisions even if it means they may lose money. Guide them as they make their choices.
Custodial Accounts: Uniform Gifts to Minors Act (UGMA) or Uniform Transfers Minor Act (UTMA)
Parents can set up custodial accounts for each child if they are under the age of 14 years. The IRS considers the minor child as the account owner, managed by the parent until the child turns age 18 years unless stated otherwise. Investments in these accounts can hold just about any kind of assets.
For children below 18, the first $1,050 of unearned income from the investment is tax-free to the child, after which the next $1,050 is taxed at the child’s tax rate, usually a lower rate than their parents’ tax rate. Income above the $2,100 is taxed at the parents’ (usually higher) tax rate. When the child turns 18, they will be paying taxes at their own rate. Couples filing jointly can contribute up to $30,000 annually for each child, or $15,000 if an individual is setting up an account. Anyone can set up a custodial account, including grandparents, aunts, and uncles.
Once the child has access to the account based on their age of majority, it is their asset. The invested money may be used for anything that child wants, including frivolous things which unfortunately the parents have little power in reclaiming that asset. We have these accounts for our kids, investing in ETFs such as QQQ. Typically, custodial accounts can be used for supplemental spending money for college.
Sometimes referred to as kiddie Roth IRAs, these custodial accounts can be opened by parents for their children. There are no age restrictions. Studies show that this generation is more aware of the need to set up IRA accounts early. Teenagers can contribute to a Roth IRA up to the earned income they make from eligible employment.
If my son Tyler is earning $2,000 as a camp counselor, he can invest all or part of the $2,000. Although there is a current maximum of $6,000 in 2020, contributions to Roth IRA is limited to his earned income of $2,000. If your teen is under 18 years, typically the age of majority, he or she are minors and a parent has to serve as a custodian. Contributions can be withdrawn at any time without penalties. The money can be invested in savings accounts although investing in a diversified low-index stock fund would likely earn far more money over a long horizon for 40 or more years.
While it would be great for your teenager to contribute as much as possible to a retirement savings account, even a portion of their earnings would be a great start. The lesson for them is the growth of their contribution is tax-free and will benefit from compounding returns over the decades.
Investing In A 529 Plan
As parents, you should set up 529 savings accounts for your children’s college education as early as possible. Your children may not even be walking or talking yet, but that shouldn’t stop you from beginning to save for your children’s future with tax-deferred dollars. As they get older, you can talk to them about this kind of investment designed to make their college costs more affordable.
It is way too early to know if they will go to college. However, getting an early jump may allow you and your children to reduce the need to take on debt. If you haven’t opened an account yet, involve your children when you open the account and explain what it is for. It is a good education to know that saving early may reduce the need for student debt later on.
9. Young Investors Have Been Opening Accounts
Due to the pandemic, major online brokers saw growth in new accounts as high as 170% in the first quarter of 2020. They were attracted by the collapse in stocks in March 2020 as lockdowns began. Brokers such as Charles Schwab, ETrade, and Robinhood, had reported that they saw the influx of young and inexperienced people. Citi Chief US equity strategist Tobias Levkovich, said in a note to clients, “New investors who sense a generational-buying moment but do not have much background in the equity space.” Trading oriented buying has dipped in names with higher volatility and questionable fundamentals. To some extent, this speculation or gambling, particularly as sporting events have been canceled.
Robinhood, Among the Largest Investment Apps
Young people have been drawn to investment apps like Robinhood. You need to be at least 18 years old to open your own account. These apps are based on financial technology or fintech platforms that do not offer custodial accounts.
The benefits of having a Robinhood account is that it is a commission-free stock trading app that allows users to invest in stocks, ETFs, and cryptocurrency. There are no required minimums for users to trade. Young investors can buy fractional shares which is great as you can more easily buy stocks with high prices like Amazon, now over $2,500 per share. Robinhood is regulated as a securities brokerage firm by the Securities Exchange Commission. Robinhood added 3 million new accounts, ending the first quarter of 2020 with 13 million accounts. Most of their customers are youthful investors who have been attracted to their gamified online platform that some worry is additive.
A Word of Caution To Your Children About Investing
Recently, Alexander Kearns, a 20 year old student at the University of Nebraska committed suicide. It seems he mistakenly believed he had a $730,000 negative balance on his account. Not all of the facts are known about this tragic event. Kara Swisher discusses the tragedy in this article. Questions that have been raised as to how does a young new investor with apparently no income get access to a $1 million investment?
My college students share their experiences on the Robinhood platform which has opened the door for them to invest. I am happy to hear about their enthusiasm but worry about their inexperience in trading options. Robinhood, along with the overall securities industry, needs to consider how to better warn and protect these inexperienced investors from making preventable errors of judgment.
Parents Can Guide Their Children To Learn More
.Making buy and sell decisions requires some knowledge and the need to do research. There are many free resources for new and experienced investors to read about the company. With some digging on the Internet, stock research may be available from experienced analysts and investors such as seekingalpha.com. Investing is very different than the more risky day trading many young people prefer to do. That is not to say investing is not risky. It is but trading requires a different skill set than investing for the long term. All investors make mistakes with real losses. That is inevitable. However, even as your children enter adulthood, take an interest in what they are investing in and whether it is appropriate. Guide them to know more about the risks and rewards of stock investments.
Parents have a role to play in encouraging their children at an early age to learn how to save and invest. The gift of starting early allows your children to have a longer time horizon and leverage compound interest. Stock investing has risks but comes with rewards that can build wealth over the long term. There are ways to lessen risks through diversification. Saving for college and retirement accounts involve basic investing skills as well. By saving more, you can teach your children how to have more flexibility. They can have the funds to allocate some of the money towards their overall financial goals.
Thank you for reading! Please join us by subscribing to our blog and get our weekly newsletter. What is your experience in speaking to your children about investing? What works and doesn’t work? We would like to hear from you!