There are many ways to talk to your kids about investing when they are most fungible, and they look up to you. It is an excellent lesson and complimentary to show them why it is vital to save and spend less. 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 0.04% APY (annual percentage yield) for all deposits. The US personal savings rate was at 9.4% for June 2021. 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.
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Why Investing Early Matters?
- 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 more significant 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 handling 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 are reluctant 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) to make 1% a year paid by the bank and grow the amount to $101. Another bank may pay a higher interest rate of 5% and extend 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 you own a piece of that company when you buy a stock such as Nike. You can grow your original investment into a more significant amount over time. You are investing over the long-term benefits of compounding, a magic concept that you can teach 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 at an early age. It occurs when your principal adds interest or gains to the initial investment providing substantial gains. It can lead to exponential growth over long periods. 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 carried 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 should we buy today?
Mom: Why Costco?
Tyler: It was jam-packed in the store yesterday. You complained to Dad that you spent more than you expected when we were there. Maybe everyone else does the same thing!
So I bought Costco shares at around $90 per share then (it’s $450.87 today) 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. 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, virtual games are user-friendly and can appeal to anyone, even digital immigrants like me. 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 and my kids at home. Parents can show their kids how to invest through the stock market games.
Most stock market game sites have many articles and videos to help new investors to understand differences in risk/reward trade-offs and measure their tolerance to make more risky purchases. Feeling gains and losses are real enough and allow 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 selling their stocks, particularly as markets get volatile. Panicking about the market usually ends up as a disaster if you get rid of 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. Before I did, my kids watched Shark Tank and enjoyed watching which products and services were hits with the investing sharks. I encourage my college students to see Jim Cramer on Mad Money, focusing 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.
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, stocks are riskier than bonds or savings accounts but provide better returns. Diversifying their portfolio is a crucial lesson on how to lessen those risks. Tell them about what kind of stocks you have and how each represents a different kind of business. Use company names they are familiar with, such as Apple, Google, Disney, McDonald’s, and Facebook.
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. Amazon shares crashed and became “dead money,” a term investors use to mean that the stock’s performance will drag for a while.
For Tyler, it was a learning experience about why diversification is essential in your portfolio. I told him it is always best to put your money into a group of 5-10 stocks that are different from each other. Concentrating all your money in one stock is a risky strategy. It is never good to put all your eggs in one basket. 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 was both falling short. Encourage your children’s active participation in stocks by setting up an investment account to make decisions on what they want to buy. Ask them to give you their reasons. As parents, we are often role models, so take advantage of their impressionable years to guide them.
Parents can enlighten their kids regarding their attitudes and investing strategies. Investing is an excellent way for families to bond together as young kids gain confidence through your experience. It is a terrific way to speak to your kids about your overall values. A significant area of investing is in socially responsible companies that have an aspect of social change embedded in their mission. These stocks or funds address critical issues related to the environment, sustainable food, energy efficiencies, and income equality. Most kids have heard of cryptocurrencies (especially Dogecoin) and may want to know more about these assets.
7. Be Honest With Your Mistakes
We all wish we did everything well. The truth is that we all make mistakes, significantly 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 the more significant mistakes that I often share with our kids is buying a lot of art and antiques at probably peak prices. I made these acquisitions before we had kids. I had purchase restrictions on what I could invest in because I worked for an investment bank. Frankly, I developed the bug to buy 18th-century Federal furniture and other collectibles. This area is a tough category for investing as tastes changes for the worse and prices fall as they did for us.
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. Start investing with your children by encouraging them to select a stock with a familiar name, service, or product.
Alternatively, you can purchase a low-cost index fund or exchange-traded funds (ETFs) that tracks the stock market and has a diversified basket of stocks.
A Guardian Account
You can establish a guardian investment account in your child’s name and the parent (s) or guardian’s name. The parent owns the account, has the legal title of its assets, 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 when they reach the age of majority. Depending on your goals for such an account, let your child make some 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 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 asset.
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 parent’s tax rate. Income above $2,100 is taxed at the parents’ (generally higher) tax rate. When the child turns 18, they will be paying taxes at their rate. Couples filing jointly can contribute up to $30,000 annually for each child or $15,000 if an individual sets 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. They may use the invested money for anything that child wants, including frivolous things. Unfortunately, parents have little power in reclaiming that asset. We have these accounts for our kids, investing in ETFs such as QQQ. Typically, you can use the custodial accounts for additional spending money for college.
Sometimes referred to as kiddie Roth IRAs, parents can open these custodial accounts 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 earns $2,000 as a camp counselor, he can invest all or part of the $2,000. There is a current maximum of $6,000 in 2021, but contributions to Roth IRA up to his earned income of $2,000. If your teen is under 18 years, typically the age of majority, they are minors, and a parent has to serve as a custodian. You can withdraw contributions 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 speak 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. Explain the nature of the account and how it will help later on. It is an excellent education to know that early saving may reduce the need for student debt.
9. Young Investors Have Been Opening Accounts
Due to the pandemic, major online brokers saw growth in new accounts as high as 170% in 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, notably due to the cancelation of sporting events.
Robinhood, Among the Largest Investment Apps
Young people use investment apps like Robinhood and Webull. You need to be at least 18 years old to open your account. These fintech platforms do not yet offer custodial accounts.
The benefit 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 excellent as you can more easily buy stocks with high prices like Amazon, now over $2,500 per share. Robinhood is a securities brokerage firm regulated by the Securities Exchange Commission. Most of their customers are youthful investors attracted to their gamified online platform that some worry is additive.
My college students share their experiences on the Robinhood platform, which has opened their door 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. There has been a meme stock frenzy which adds to volatile trading by young investors.
Parents Can Guide Their Children To Learn More
Making buy and sell decisions require 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 professional 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 actual 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 to learn how to save and invest at an early age. The gift of starting at an early age 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 involves 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 The Cents of Money 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!
With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.