Investing, essentially, is putting your money into something with the hope of a financial return, and it’s one of the best ways to build wealth and save for your biggest financial goals, from retirement to your dream home.
While most people start investing as adults, investing as a teen can give you a huge head start on saving for the future and learning vital money lessons.
Investing may sound complicated, but it’s easier than you’d think to get started (yes, even for teens). In this article, parents and teens will learn the benefit of investing as a teenager, the best investments for this age group, and what accounts you can use to start investing.
- Investing as a teen gives you an opportunity to grow even more wealth thanks to compound interest and also gain financial literacy skills from a young age.
- Some of the best investments for teens include high-yield savings accounts, CDs, stocks, bonds, and pooled investments.
- A custodial account is one of the most popular ways to start investing for a teen, though a custodial IRA is also a great option for a working teen.
Why You Should Help Your Teen Start Investing Early
Individuals who start investing as teens rather than waiting until later in life have a huge advantage over their peers, both in their potential returns and the knowledge they can gain from investing.
“Age is arguably a younger investor’s most valuable asset. This is because of compound interest, or the ability of your money to start earning its own money,” Taylor Jessee, a CPA and CFP and the director of financial planning for financial consulting firm Taylor Hoffman, shared. “The earlier you start investing, the longer you’ll have your money being put to work for you.”
Let’s take a look at an example. Imagine a 15-year-old who starts investing $150 per month into a brokerage account with a 10% annual return. If they were to invest just $150 per month until age 60, thanks to compound interest they would have more than $1.3 million saved. On the other hand, someone who started investing the same amount at age 35 would have less than $180,000 by age 60.
The money that your teen earns in their investment account can help them pay for college, buy a home, start a family, travel the world, start a business, and more.
Not only does investing as a teen help young adults prepare financially for the future, but it also helps teach them financial literacy. For many, personal finances are a source of stress and anxiety. A 2018 National Financial Capability Study from the Financial Industry Regulatory Authority (FINRA) found that 53% of Americans consider their finances to be a source of anxiety, with respondents ages 18 through 34 reporting the highest levels of stress. By helping your teen to build their financial literacy from a young age, you may help them to feel more confident and less anxious about money matters later on.
What Teens Should Invest In
With so many investments to choose from, all of which have varying levels of risk, it can be difficult to know where to start investing. Below are some of the most common investments available to teens as well as some of the downsides you should be aware of.
High-Yield Savings Accounts
A high-yield savings account (HYSA) is the most basic way for a teen to start earning a return on their money. Savings accounts have been around for a long time, but more financial institutions now offer high-yield savings accounts, which offer a higher interest rate than a standard account. With a higher interest rate, your funds will grow more than they would in a typical savings account. Unfortunately, even savings accounts with high yields have very low rates of return, compared to other investments.
There’s no risk to putting your money in a HYSA. The money is insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC).
Certificates of Deposit
A certificate of deposit (CD) is a banking product similar to a savings account through which a teen can earn interest from their savings. The key difference is that CDs require you to keep your money in the account for a specific period of months (or even years) to earn the promised interest rate. Then, when you redeem the CD at maturity, you’ll get your money back in addition to the interest your account earned.
Like savings accounts, CDs are considered a risk-free investment because the money is insured by the FDIC up to $250,000. The downside, however, is that your money is essentially locked up for a period of time.
A stock is a way to take a piece of ownership—also known as "equity"—in a publicly traded corporation. When you own a stock, you become a shareholder and part-owner of the company. Investors can earn money from dividends that companies pay to their shareholders as well as through capital gains when the value of the stock increases.
“You could take a small piece of your portfolio and pick one or two stocks as a way to learn how to follow and evaluate individual stocks,” Jessee said. “Consider picking one or two companies you’re familiar with, so it’s easier to follow and relate to.”
For parents and guardians, Jessee recommends adding stocks to your child’s portfolio as a complement to more diversified investments rather than building a portfolio entirely of individual stocks. Stocks tend to be volatile assets, meaning they can undergo major price shifts in a short period of time.
Before adding stocks to your teen’s portfolio, you can work together to open a virtual trading account—also known as "paper trading"—where you can practice buying and selling stocks without real funds. Virtual trading can give your teen an idea of how the stock market works, without putting any actual money at risk.
A bond is a type of debt security. When you purchase a bond, you’re essentially lending money to the issuing company or government entity. While bonds might not necessarily be as exciting to a teen as stocks, they’re generally more stable investments, meaning they help to create a well-diversified portfolio. Bonds usually provide a fixed income, thanks to the interest payments the bond issuer makes throughout a set period of time.
Funds, primarily mutual funds and exchange-traded funds (ETFs), are popular investments that allow you to gain exposure to many different securities in one investment. Mutual funds and ETFs are known as "pooled investments," because they pool together the money of many investors.
- Mutual Funds: A mutual fund is technically a type of investment company that pools the money from many investors to create a well-diversified portfolio. Each investor is part owner of the fund, with a share in its profits and losses. All mutual fund orders are settled at the end of the trading day, regardless of when they were placed.
- Exchange-Traded Funds (ETFs): An ETF is another type of pooled investment that allows investors to add many securities to their portfolio through a single investment. One key difference between ETFs and mutual funds is that ETFs trade throughout the day like stocks. Like a stock, you can buy one share of an ETF and have more control over the price. “I usually recommend starting with an index ETF or mutual fund so you get immediate access to a diversified portfolio instead of putting all your eggs in one basket with just one stock,” Jessee said. “This makes even more sense if you’re starting out with a small dollar amount to invest.”
Opening an Investment Account for Teens
If your child is under 18 years old, the most effective way to start investing for or with them is to open a custodial account. With this type of account, an adult “custodian” opens an account and can save and invest money on behalf of the child. Then, when the child reaches adulthood—either 18 or 21, depending on the state—they’ll take full control of the account.
“Keep in mind, assets in a custodial account legally belong to the child—the account beneficiary,” Jessee said. “The parent or custodian is merely a placeholder until the child reaches legal adulthood. This means that if a parent puts money in a custodial account for a child, it is considered an irrevocable gift and cannot be taken back. In other words, that money now belongs to your child.”
There are two common types of custodial accounts: Uniform Gifts to Minors Act (UGMA) accounts and Uniform Transfers to Minors Act (UTMA) accounts. The two are almost identical but vary in the types of assets they can hold. UGMA accounts can hold financial assets like stocks, bonds, mutual funds, and cash, while UTMA accounts can hold all of those same assets as well as physical assets like real estate.
Another type of custodial account is a custodial individual retirement account (IRA), which allows teens and their parents to start saving for retirement before they reach adulthood. Similar to a UGMA or UTMA account, an adult custodian opens the IRA on behalf of a minor. Then, the family can contribute up to the child’s earned income for the year or up to $6,000, whichever is less.
The Bottom Line
Most people understand that they should be investing, but many may not have considered the benefit of investing for or with their teens. Getting teens started with investing at a young age can help them to build wealth and financially prepare for the future as well as provide them the financial literacy they will need to succeed later in life.
Frequently Asked Questions (FAQs)
How old do you have to be to invest in stocks?
Investors under the age of 18 are generally prohibited from opening their own brokerage accounts. However, adults can open a brokerage account on behalf of a child of any age, allowing them to get a head start on investing. Keep in mind that even in the case of a custodial account, the adult custodian, not the child, has control of the account and the investment decisions.
Who pays taxes on custodial accounts?
Because the assets in a custodial account legally belong to the child, they’re subject to the tax rules that govern children’s unearned income (informally known as the "kiddie tax").
Under the kiddie tax, the first, $1,100 of a child’s unearned income is exempt from federal taxes. The next $1,100 is taxed at the child’s tax rate, which, assuming the child has little to no income, will likely be the lowest tax bracket. Finally, any earnings above $2,200 are taxed at the parents' tax rate.