A recent study conducted by Greenlight Financial Technology, Inc., found that 86% of teens are interested in investing, but many don’t feel confident enough to do so. And considering investing isn’t a topic many children learn in schools, it often falls on parents and guardians to teach their kids this important life skill.
“If your child shows an interest in investing, seize the moment to share what you do and why you invest the way you do,” said Rob Phelan, a high school personal finance teacher and the founder of The Simple Startup, which helps beginner entrepreneurs find their footing
In this article, we’ll cover the basics of what investing principles to teach your child, types of investment accounts to consider, and how to open an investment account that best fits your child’s needs.
- Before taking a hands-on approach to investing, teach your child some of the fundamental principles such as compound interest, diversification, and risk tolerance.
- While minors can’t open their own brokerage accounts, parents can help them start investing in a custodial account, 529 plan, or Roth IRA.
- You can help your child understand investing by teaching about goal setting, building a diversified portfolio, and more.
- When it comes time to file taxes, use this opportunity to teach your child about the tax consequences of investing, since there may be taxes owed on their investment earnings.
What Do Kids Need To Know About Investing?
Investing is a tool that one can use to build wealth, and it’s often the next step after saving.
Before you dive into buying stocks or investing in mutual funds with your child, it’s important to start with some of the basic principles. Teaching your child these principles before you start investing will give them a more solid foundation on which to build their investing education.
Investing is a more advanced concept. When teaching it to children, you should build onto an existing education about budgeting, saving, and other financial fundamentals. Phelan suggests encouraging your child to save first through jars at home, and later in a bank (with your assistance), to build that foundation.
Once the groundwork is there and your child is ready to learn about investing, here are a few basic principles to start with:
- Compound interest: It’s important that your child understand why investing is so powerful in the first place. Teach them the importance of time in the market: The younger you start, the better chance you have of earning more. And show them not only how compound interest can work in their favor when investing, but also how it can work against them when they’re in debt.
- Diversification: One of the most important investing principles is not to put all your eggs in one basket. Teach your child the importance of having many different securities in their portfolio rather than just investing in a single company.
- Risk tolerance: From a young age, teach your child about the tradeoffs of risk and reward. Investments that have high potential rewards often have higher risks, and it’s important to find a balance you feel comfortable with that’s appropriate for your investment goals and timeline.
- Patience: Like most things in life, investing takes time. Teach your child that investing isn’t a get-rich-quick scheme. The goal is to put money into the market and watch it grow for many years rather than expecting a quick return. This lesson will give your child more realistic expectations of investing from the start.
Types of Investment Accounts for Kids
Children under the age of 18 generally can’t open their own brokerage account. However, there are several types of accounts specifically designed for young people who want to invest.
Custodial Brokerage Account
A custodial account such as an UGMA or UTMA account is a type of brokerage account that an adult opens on behalf of a minor. The adult who opens the account—known as the custodian—can contribute to the account and choose the investments. When the child turns either 18 or 21, depending on the state, they take control of the account.
One word of caution with UGMA and UTMA accounts is that contributions are considered an irrevocable gift to the child, meaning you can’t take the money back out. And once the child reaches the age of majority, they’re free to do whatever they want with the funds.
A 529 plan is a tax-advantaged investment account designed to help families save for college. The funds in a 520 plan grow tax-free as long as they’re in the account. And as long as you use the funds to pay for qualified education expenses, including tuition, fees, and room and board, you won’t pay taxes on your withdrawals.
The major downside of these accounts is that if the money isn’t used for qualified education expenses, you’ll pay income taxes on the withdrawals, as well as an additional 10% penalty on the earnings.
Custodial Roth IRA
A final account to consider opening for your child is a custodial Roth IRA. It’s a tax-advantaged account where contributions are made with after-tax dollars. The funds then grow in the account tax-free, and your child can withdraw them tax-free during retirement. This type of account is specifically designed to help your child save for retirement. Like a custodial brokerage account, the custodian manages the account until the child reaches the age of majority (18 or 21 in most states), and then they take over the account.
To contribute to a custodial Roth IRA, your child must have earned income, and the contributions cannot exceed $6,000 or their earned income, whichever is lower. A family member or friend, however, can make this contribution on behalf of your child, too.
Because Roth contributions are taxed at the front end, they can be withdrawn from the account at any time (only the contributions, not the earnings). Additionally, both the contributions and earnings in a Roth IRA can be used without penalty to pay for qualified expenses like college or the purchase of a first home.
How To Open an Investment Account for Kids
Are you ready to open an investment account for your child? Each of the three accounts we listed above has its own advantages and disadvantages. However, custodial accounts provide the most flexibility because there aren’t limits on what your child can use the money for.
Once you’ve decided on the type of account to open, you’ll also have to choose the right brokerage firm. There are many online brokerage firms to choose from, and it can be challenging to choose the right one for your family’s financial situation.
Before choosing an account, consider the following:
- What type of securities you want to purchase for your child
- The fees associated with the firm you choose, such as transaction costs
- The user interface
- The types of accounts available
- Any other features that are important to you, such as parental controls like limited access
When opening an account, brokers typically request personal information from their customers, including financial and tax identification information. The good news is that once you choose a broker and provide your information, you can open and fund the account in a matter of minutes.
Tips for Teaching Kids About Investing
There are more resources available than ever for children and adults of all ages to learn about personal finance and investing. From school to social media to eBooks, the options are endless.
“If their school offers a personal finance class or elective, sign them up,” Phelan said. “Not all schools require personal finance to graduate, but many still offer the class as an elective.”
If there’s no personal finance class at your child’s school—and even if there is—there’s still plenty you can do at home to teach them about this important topic.
Set Investing Goals With Them
“When I teach personal finance to high school seniors, our investing section will always start with goals and establishing what are some things we want to achieve in the short-, medium-, and long-term future,” Phelan said.
Starting with specific financial goals has several benefits. First, it teaches your child to be intentional with their money. And second, it also helps you teach them to match their investment portfolio to their goals since short-term and long-term goals require a different approach.
Start With a Diversified Portfolio
As mentioned, diversification is one of the most important principles of investing, and it’s one you’ll want to teach your child right away. Talk to them about the different ways they can diversify their portfolio. And use this opportunity to discuss mutual funds and exchange-traded funds (ETFs), which make it easy for them to build a diversified portfolio with few investments.
Review Their Investments Together
Investing is a long-term endeavor, but teach your young one not to take an entirely set-it-and-forget-it approach. As they get older and actually start investing in various assets, schedule a time once per month or quarter to sit down together and review their investments.
Doing this will help prepare them for market ups and downs. You can talk through their feelings or worries with them when their investments lose value, as well as talk about how the overall economy will affect their portfolio. The good news is that they’ll generally eventually see their investments rebound, which is another learning opportunity for them.
Have Them Invest Their Own Earnings
Once your child has a job and starts earning money of their own, consider having them invest some of their own earnings. They’ll be able to take even more ownership of their investments and understand the importance of fitting your investments in with the rest of your budget. For a teen that’s earning money, Phelan recommends putting those funds into a custodial Roth IRA.
You can start this process even earlier if your kid earns an allowance. Together, you can walk them through the process of putting away some of the funds they earn into an account.
Make It Fun
Children can have short attention spans, and investing can be a complex topic. To keep them engaged, find ways to make the experience more fun and personalized. In addition to building a diversified portfolio, set aside a small portion of their account to invest in companies they’re excited about. It will give them a sense of ownership and connection to a brand they use and love.
Try to find a balance between making investing interesting and exciting for your child without gamifying it. The goal is to teach your child the fundamentals of long-term investing, and if you focus only on investing in individual stocks, they may walk away with the wrong lesson.
You can also meet your kids where they are by checking out various financial educators on platforms like YouTube and TikTok. But it’s important to do your research and proceed with caution.
“Help them to follow good sources of investing information on social media,” said Phelan. “There are a lot of questionable influencers pushing high-risk strategies for investing on platforms like Instagram and TikTok, so treat this as a learning moment for both of you and evaluate different sources of information together before following an account.”
Taxes on a Kid’s Investment Account
Before you open an investment account for your kid, it’s important to understand the tax implications. The taxes on your child’s investments will differ depending on the account you choose. As we mentioned previously, both the 529 plan and the Roth IRA allow the money to grow tax-free and are eligible for tax-free withdrawals, as long as it meets certain requirements.
But the tax consequences for a custodial account are a bit different. With this type of account, your child will pay taxes on their investment earnings under what’s known as the “kiddie tax.” The first $1,100 of your child’s unearned income (which includes investment earnings) is tax-free. The next $1,100 is taxed at your child’s tax rate. Any income above $2,200 will be taxed at the parent’s tax rate, assuming it’s higher than the child’s.
Remember that filing a tax return for your child’s investment account can be another learning opportunity. Involve them in the process to teach them about filing taxes and about the tax consequences of investing.
Frequently Asked Questions (FAQs)
How do you buy stocks for kids?
While children can’t open their own investment accounts, parents can open custodial accounts on their behalf and help them to buy stock there. Once you’ve opened the account, you can use it as a teaching tool to help your child buy stock in companies they’re excited about.
How should a kid invest with $20?
Today it’s easy to build a diversified investment portfolio with only a small amount of money. If your child has $20 to get started with, consider investing it in an index fund that tracks the S&P 500 or the total stock market so they can get broad market exposure with just one investment.