MarketWatch: Teach Your Children to Invest, not Spend
As a guest speaker at colleges and high schools, I discovered that most teenagers are clueless about investing. They get an “A” for knowing how to spend money, and many work hard for income, but few know how or why they should invest in stocks, mutual funds, or index funds. Typically, most teenagers haven’t thought about building wealth by paying themselves first.
Sometimes the biggest obstacle to making money is our perception. We believe investing is rocket science, or something that only professionals can do. By giving your children the confidence to manage and invest their own money, they can learn to be financially independent with the freedom to do what they want in life.
Do you want your children to be spenders or investors? In reality, they can be both. Before your children get their first credit card, show them how to make money work for them by investing.
Here are some actions you can take if you want your children to build wealth:
1. Open a joint brokerage account: Stick with self-directed brokerage firms such as TD Ameritrade, Fidelity Investments, Charles Schwab, and eTrade Financial (to name a few). If your children do not know what a brokerage firm is, use this analogy: a brokerage firm is like a shopping mall but instead of spending money on clothing or electronics, you’re buying different investments that can make money.
2. Open a UGMA (Uniform Gift to Minors Act) account: A UGMA is a custodian account used to hold and protect assets for minors until they reach legal age. The account can be opened at most brokerage firms with no minimum amount. Talk to the representatives for details in opening a UGMA in your state.
3. Consider potential tax consequences: Talk to a tax professional or the brokerage firm representatives before you open an account. When your child reaches legal age, the custodian (you) must hand over the assets to your child.
4. Start with an index fund: The first investment your teenager should make is in a low-cost index fund such as a S&P 500 ETF (exchange-traded fund) that tracks the S&P 500 your brokerage firm will have a list of the most popular). The S&P 500 Index contains a group of 500 large U.S. companies, so when you buy the S&P 500 Index, you are buying a small piece of every company in the index.
5. Have a routine: The goal in opening the account is to get your child into the routine of investing a certain amount of money into the fund every month (you could also set up an automatic payment plan). If needed, use a portion of his or her allowance to invest in the fund. Here’s a hint: Match by 50% any money your child invests. (If your child invests $100, add an additional $50, etc.). Look for reasons (like a birthday) to add money to the fund.
6. Think outside the box: The idea is to get children to think differently about how to manage money. By opening a brokerage account, you can show your children the value of routinely paying themselves the first of each month (in contrast to making a credit card payment).
7. Dig into the details: Show your child how to read the brokerage statement (either online or by mail), and how to follow the index fund prices (which are posted online at dozens of websites including here). Your children will see how easy it is to make (or lose) money every day without much effort, or having to be involved with the financial industry.
Here are some other ideas to consider:
1. Teach patience: Regular, monthly allocations can help your child learn how to be a disciplined and patient investor, attributes they will need as they get older. With the power to manage their own money, they won’t need to depend on others to invest for them.
2. Teach the difference between investing and speculation: Some teenagers will be so fascinated by the market they may be interested in speculating in individual stocks, or in the latest investment fad. That is fine, but keep the good old reliable index fund separate from any speculative investments.
3. Teach market realities: As the index fund appreciates, your children may experience the thrill of making money in a bull market, or the agony of losses during a correction or bear market. The odds are good that over their lifetime, the account will grow in value (although there are no guarantees). The secret is to keep adding to the account and letting it grow on its own.
In addition, help your child become financially literate without overwhelming them with financial terms. They may have questions about how money grows in value (compound interest), why they should put a certain amount in the account every month (dollar-cost averaging), why the index fund goes up or down (profitable companies within the fund go up in price, or vice versa), or if they can invest in something else (diversification). I suggest not teaching these concepts unless they ask.
After your child has learned how to be an index investor (it can take years), they may want to select various mutual funds, or buy individual stocks. For now, however, teach your children to follow the market rather than trying to pick winning or losing stocks.
After the investment account gets even larger, it will be hard for most people to resist withdrawing money (unless for a good reason such as college or their first house). But if your children can make investing a lifelong habit, starting as early as possible, they can focus on accumulating wealth rather than only spending. Teaching your children how to invest is one of the most important gifts they will receive, and the time to start is right now.