When I was a kid, the word “investing” never entered my family’s dinner table conversation. Or our carpool ride conversation, or weekend conversations, or any conversation. We didn’t talk about investing.
So many people grow up this way, where talking about money and investing never involved the kids.
As adults, many of us want to change this for our kids. Especially those of us who have discovered the power of real estate investing for retirement or passive income. We want to break this cycle and help our kids understand how money works and the freedoms that it can unlock to lead the life we want.
For me, the big “ah-ha” moment of investing didn’t hit me until I had my first kid. I remember sitting on the couch with my 1-yr old daughter asleep on my chest and realizing that I needed more time. I didn’t want to work 40-50 hours and miss her childhood. I needed to become financially independent as soon as possible, or at least start building up passive income streams to free up my time.
I also wanted to help her learn about investing earlier than I did – at the embarrassing age of 34.
But how do we help our kids learn more about money and how to invest so that they can get money working for them (sooner than we did)?
Investing for kids offers more than just early wealth accumulation; it’s a practical way to instill financial literacy from a young age. In this article, we’re going to give you a full guide on how to get started. We’ll cover how to choose the right investment accounts for kids, engage them with foundational concepts, and teach them the importance of financial independence.
Starting kids early on with financial literacy and investing can equip them with crucial money management skills and the power of compound growth for long-term wealth.
Various investment accounts like 529 plans, Custodial IRAs, and UGMA/UTMA accounts offer different benefits and tax implications, suiting various educational and investment needs suited for children.
Hands-on learning with stock market games and real estate investments, involvement in family financial decisions, and the strategic use of tax benefits are practical ways to nurture a child’s financial acumen.
Empowering Young Investors: Why Start Early?
Believe it or not, the world of investing isn’t just for adults.
In fact, introducing your children to investment concepts at a young age can lead to better money management skills and long-term wealth accumulation. Yet, fewer than a quarter of American high school students will take a personal finance course, which shows a large gap in formal financial education.
When children embark on their investment journey at a young age, they two gain a distinct advantages—over a decade’s worth of additional experience compared to the average American who starts investing later and the ability to leverage the magic of compounding earlier.
This early exposure to investment education arms them with knowledge about investment strategies and risk management skills, laying a strong foundation that considerably enhances their future financial success prospects.
And tacking on another decade or two of compounding (especially in the early years) can make millions of dollars of difference for our kid’s wealth. The trick here is introducing the power of compounding early enough that they can see it working. They can have that the “ah-ha” moment earlier.
Building a Foundation of Financial Literacy
The key lies in initiating the conversation and incorporating habits.
Financial literacy, which refers to the capacity to understand and handle basic financial activities, should be introduced to children as early as possible. You may wonder, “How do I start talking about finances with my child?”
Don’t worry, it’s simpler than you think.
Picture this. You’re in the grocery produce section and making a decision about which fruit to buy. Your kids excitedly point to the star fruit. Great. You know it looks cool, but they won’t actually eat it. It also costs as much as 7 bananas.
Tell them how much that fancy star fruit costs and compare it to the bananas. Later on at the check-out show them how much it costs.
Simply talking about money is a great place to start.
Starting conversations about finances early with children helps to foster healthy financial habits and prevents the development of unhealthy attitudes towards money. You can engage your child in learning financial concepts by:
- Including them in family budgeting discussions
- Using age-appropriate language about saving and spending
- Providing tangible examples of purchasing decisions like toys
- Tell them how investing is like sending your money to work at a job for you
- Sharing financial information in a manner suited to their age and comprehension levels
- Utilizing technology to aid their understanding and research capabilities
The Power of Compound Growth
Compound growth, a term often synonymous with an investor’s best ally, is particularly advantageous for those who commence their investment journey at a young age.
The difficulty is that compounding doesn’t get exciting for at least 20 years or more.
But what if you could fast-track those early years of uninspiring compounding? When kids start investing – even small amounts – as soon as possible, they can start to see the incredible power of compounding right as they leave the house and start
Basically, the power of compounding interest amplifies over time, which makes it extremely beneficial for early-start investors.
Just how powerful is compound growth? Let’s take an example.
An individual investing $1,000 annually with an 8% return rate starting at age 25 could accumulate $258k by age 65, showcasing the power of compound growth. However, if that same person invested $1,000 annually starting at age 5 (with their parent’s strategic support), they could accumulate $1.35M by the time they are 65.
That’s almost a $1.1M difference!
Even a one-time investment of $10,000 at age 20 has the potential to grow to over $70,000 by age 60 at a 5% interest rate, exemplifying the long-term advantages of early investing and compounding. Remember, compounding doesn’t only happen in the stock market. When we continually invest in real estate and reinvest our profits, we can compound our earnings too.
Overcoming Investment Hurdles with Time
One of the biggest advantages that young investors have on their side is time. Children can significantly benefit from a longer investment horizon as they have more time to recover from losses and build wealth over time. This extended investment period allows young adults to take on more risk and learn from both successes and failures in investing. These experiences are invaluable in making better decisions over their investment period.
Remember, delaying investment can result in significant shortfalls, such as over $30,000 by age 65 for those who start investing ten years later with the same annual amount.
Selecting the Right Investment Accounts for Kids
After your child has grasped the fundamental concepts of investing, the subsequent step involves setting up an appropriate investment account for them. However, given a multitude of options, how do you determine the right pick? From 529 plans for college savings to custodial IRAs for children with earned income, the choice depends on your child’s needs and your financial goals.
529 plans offer several advantages for college savings, including tax-free growth and federal tax-free withdrawals for qualified education expenses. You can also leverage a Whole Life Insurance Plan to help your kids invest and pay for college. Even real estate investments can pay for college if you create a strategy.
However, it’s important to be aware of the tax implications. For instance, the first $1,250 of a child’s unearned income is subject to the standard deduction, beyond which the income is taxed progressively at the child’s and then the parent’s tax rate.
Custodial IRA and Roth IRA Options
If your child has earned income, a Custodial Individual Retirement Account (IRA) may be a great option. These accounts can be opened for a child with earned income and provide tax-deferred growth, managed by a parent until the child reaches adulthood.
TIP: Your child can earn income even if they don’t have a traditional job. If you have a side business (like a real estate business, consulting services, etc.), you can pay them for their work. For instance, I pay my kids to appear in photos for our AirBnB business. I contribute the money directly into their Custodial Roth IRA account.
Custodial IRAs can be either traditional or Roth IRAs, with traditional IRAs potentially offering tax deductions on contributions, and Roth IRAs offering tax-free withdrawals. A custodial Roth IRA requires that the minor has taxable income, typically from a part-time job, making it ideal for working children.
Contributions to custodial Roth IRAs grow tax-free, and distributions are also tax-free, offering a significant advantage when used as retirement savings. Additionally, funds from custodial Roth IRAs can be withdrawn without penalties for qualified educational expenses before retirement age.
Educational Savings Plans
Education is a significant investment, and starting early with the right savings plan can make a huge difference. 529 savings and investing accounts offer tax-free growth and withdrawals for qualified expenses, providing an advantage for future education expenses. Consider opening a savings account specifically dedicated to education expenses to further secure your financial planning.
Earnings within a 529 plan offer several benefits:
- They are tax-free for qualified higher education expenses
- They are favorable when it comes to federal aid eligibility
- Some states may offer tax deductions or credits for contributions to 529 plans.
Apart from post-secondary education costs, some 529 plans permit tax-free withdrawals for K-12 tuition expenses up to certain limits.
Trust Funds and UGMA/UTMA Accounts
Trust funds and UGMA/UTMA accounts are another viable option for your child’s financial future. A custodial trust account, such as UGMA/UTMA, can be opened by a parent or relative for a child, allowing contributions to be invested in a variety of assets like stocks, bonds, or mutual funds. The custodian manages the funds until the child reaches legal age.
These accounts offer flexibility in how the funds are used, provided it benefits the child, covering a wide array of expenses from education to major purchases like cars or homes. However, as children can take control of their UGMA/UTMA account upon reaching the age of majority, they must be taught sound financial habits to responsibly manage their money.
Practical Steps to Teach Children Investing Basics
Having examined the different investment accounts, we can now proceed to discuss some hands-on strategies to make the learning process about investing enjoyable and captivating for your child. From interactive games to real estate investment simulations, there are plenty of ways to teach children the investing basics.
Interactive games like ‘Chair The Fed Game’, ‘Gen I Revolution: Online Personal Finance Game’, and ‘Financial Soccer’ can help children understand the basics of economics and personal finance. Real-world scenarios, such as planning for prom expenses with the ‘Plan’it Prom App’, introduce teens to the concept of budgeting in a relatable context.
Engaging Through Stock Market Games
One of the best ways to learn is through play. Stock market games like The Stock Market Game™ by the SIFMA Foundation allow children to learn investing basics in a risk-free, educational context.
Games such as MarketWatch Virtual Stock Exchange, Investopedia Stock Market Game, and Wall Street Survivor offer real-time trading experiences with virtual portfolios. Using these stock market simulations and educational games helps develop investment understanding and skills without financial risk.
Related Podcast: Give Your Kids A Head Start With Rapunzl Investments Games
Real Estate Investments for Kids
Real estate investments can also be an effective tool for teaching children about finances and investments. Children can gain hands-on experience by participating in their parent’s real estate investing activities, such as managing rental properties or evaluating real estate syndication investment opportunities.
Older children may have the opportunity to learn about and participate in real estate crowdfunding syndications, providing them exposure to large-scale investment projects. This is possible because of Regulation Crowdfunding, which is a non-accredited investing pathway. Because investors don’t have to qualify as accredited, younger adults (like your college-student kiddo), can invest. This is typically done by joining other family members inside an LLC, essentially investing as a unit with the child’s name on the asset.
Engaging children in real estate investment not only educates them but can also lead to potential financial benefits and develop lifelong investing acumen.
A creative way for kids to invest in passive real estate investments, like syndications, is to allow them to join you in an investment as a real “simulation.” Julie Lam, owner of Goodegg Investments, has done this with all 3 of her kids.
Related Video: What I Want My Kids To Know About Real Estate
She does this by allowing her kid’s to “invest” a certain amount, like $1,000. If her total investment is $50k, then the child would receive 2% of all earnings on this investment. She has her kids follow along with the monthly updates and quarterly financial reports so that they can see what is happening with their investment.
While her kids aren’t legally named on the investment, since they are younger than 18, they can see how their money can work while invested passively in real estate.
Setting Up Your Child’s Investment Portfolio
Establishing your child’s investment portfolio constitutes a pivotal step in their financial journey, involving the selection of suitable types of accounts and investments that align with their requirements and objectives.
A diversified portfolio of investments for kids can include:
Accounts for index fund or mutual fund investing
Ways they can “invest” in real estate
A custodial IRA account, which is an essential portfolio piece for kids since it allows them to start growing their money as early as birth in the stock market.
Diversification with Stocks, Mutual Funds, and Real Estate
Diversification is a key strategy in investing. By investing in a variety of assets, you can help manage risk and potentially increase returns.
This may seem advanced for kids (it is for most adults who blindly invest in their employer’s 401k provider’s mutual funds). But starting with a diversified portfolio early, or simply talking about different asset classes, will expose kids to different types of investing. You never know which they’ll be most interested in learning more about.
You’ll want to foster and encourage any bit of interest at this stage. If your child wants to know more about how to renovate a kitchen to increase the value of a rental unit, keep the conversation going. Or if they want to understand stocks, follow that lead.
A custodial account enables young investors to diversify their portfolios by investing in custodial accounts, which include:
- individual stocks
- mutual funds
- index funds
- exchange-traded funds (ETFs)
While individual stock investing is not a typically recommended strategy for the everyday investor, it can be helpful for kids learning about investing. They can follow along with a company’s performance and see how that stock performed. Many adults don’t understand this simple connection – the value of stock and the performance of a company.
When choosing individual stocks for stability in a young investor’s portfolio, considering well-established companies from the Dow Jones Industrial Average can be beneficial. Some examples of these companies are:
- The Coca-Cola Company
The Role of Brokerage Accounts
A brokerage account plays an important role in managing your child’s investments. These accounts allow your child to buy and sell a wide range of investments, including:
- mutual funds
A brokerage account is just an investment account. By utilizing brokerage services, your child can effectively manage their investment portfolio.
Parents should look for advisory or brokerage services that offer custodial brokerage accounts for their kids with:
- No account fees
- No minimum initial deposit requirements
- Low or no trade commissions
- A large selection of low-cost index funds
- Educational content including online tutorials and practice accounts.
Building The Road To Financial Independence
Fostering the excitement of financial independence in your child is among the most valuable gifts you can provide. It extends beyond merely teaching them to save or invest; it involves helping them comprehend the worth of money and the art of managing it.
When we become excited about the power of compounding, investing, and managing our money (we know, not everyone gets giddy with these topics), the more likely they will take action and trust in the long-term process.
We know, teaching delayed gratification in our kids isn’t easy. But it’s worth every effort you can make.
An early start in investing is fundamental for overcoming reliance on systems like Social Security, ensuring financial independence in retirement, or the freedom to start a business with more financial security.
This process begins with guiding your child from managing an allowance and saving a portion each month to budgeting part-time job earnings. As your child grows older, they should transition to creating a monthly budget to manage spending from their part-time job earnings, which represents a more complex financial responsibility than handling an allowance.
Related Article: Achieving Financial Freedom: How To Be Financially Free
From Allowance to Part-Time Job
Giving kids an allowance, say $5 each month, won’t naturally make them good with money.
We suggest helping them by setting up automatic contributions. For instance, they could contribute to charity, long-term savings, and the family bank. This last bucket, the family bank, is where you pay interest on their money (an inflated interest rate to get them more excited) so that they can get excited to invest.
Kids won’t necessarily be excited to invest (even though their parents might love it – like us).
By giving them a 10% interest rate, earned every month, they can see the magic of compounding as soon as possible.
Talk about how much interest their money is earning every month as if it were at a job. The more they understand that money can work to earn more money, the more excited they’ll be to save and invest.
The transition from allowance to part-time job earnings is a major step in your child’s financial journey. This step involves more than just earning money; it’s about learning how to manage it effectively and make smart financial decisions.
Investing in education and skills development is crucial as it equips teenagers with human capital that can secure higher wages and better investment opportunities in the future. Helping teenagers to be realistic about the income prospects of their chosen careers can guide them toward making informed educational and financial choices. And to stay out of debt.
Involving Kids in Family Investment Decisions
Involving your child in family investment decisions can be a great way to teach them about finances and investing. It fosters a sense of teamwork, responsibility, and accountability. If you do nothing else for your kids, you should at least involve them in your own investment decisions. Having this early exposure and destigmatization of talking about money can help kids take on their own finances earlier in life.
Introducing kids to the family’s financial goals can motivate them to make necessary changes and understand the reasons behind frugal decisions. Celebrating financial milestones and successes with children helps them feel part of the team and appreciate the value of hard work and goal-setting.
Empower Kids To Save For College
With college education costs escalating, initiating savings early becomes imperative. Enabling your child to save for college not only lightens their financial load but also imparts crucial financial lessons to them.
Having extraordinary amounts of college debt upon graduation is a difficult weight to emulate early. However, when they graduate debt-free and their friends are not so lucky, they will be massively grateful.
Understanding tax benefits and implications is key when saving for college. Here are some important points to consider:
The Kiddie Tax is applied to a child’s excess unearned income over $2,500 for the tax year.
The excess unearned income is taxed at the parent’s marginal tax rate.
It’s important to manage investments carefully to utilize more favorable tax conditions for minors.
Keeping Up with Tax Benefits and Implications
Saving for college is not just about putting money aside; it’s about understanding the tax benefits and implications that come along with it. Capital gains on a child’s investments might be taxed at the child’s or parents’ tax rate depending on certain thresholds, necessitating strategic planning to minimize tax liabilities.
Staying informed about changes in the federal budget, as in the ‘Kids’ Share 2023’ report, can aid parents in planning for and taking advantage of tax benefits for their child’s investments. Parents must also consider how their child’s investments may affect financial aid calculations when filing the FAFSA for college, as it can have implications on the eligibility and amount of aid received.
Adjusting to Market Changes
Investing isn’t a one-time act; it’s a continuous journey that requires constant monitoring and adjustments. Market trends influenced by policies in areas like child care, education, and health can significantly impact investment strategies tailored for children.
The ‘Kids’ Share 2023’ report provides insights into future projections and economic mobility affecting children’s investment opportunities.
In conclusion, teaching your child about investing is a gift that keeps on giving. From understanding the basics of financial literacy to navigating the world of stocks, bonds, and real estate investments, every step in this journey equips your child with invaluable skills that will serve them well into adulthood. Don’t wait. Start your child’s financial journey today and open the doors to a future of financial independence and success.
Frequently Asked Questions
How to invest $1,000 for a child?
To invest $1,000 for a child’s future, consider opening a brokerage account or a custodial account, or look into a 529 college savings plan with gifting options. You can also simulate an investment in one of your real estate investments, giving them their share of the earnings without having their name legally on a property or in the entity. These options can help grow the investment for the child’s future.
Can a 12 year old start investing?
No, technically a 12-year-old cannot start investing on their own, but they can have an adult open a custody account that will transfer to them at 18. However, parents can do a lot to simulate investing for kids that feels just as real.
What are some practical ways to teach children about investing?
You can teach children about investing through interactive games like ‘Chair The Fed Game’ or ‘Gen I Revolution: Online Personal Finance Game’. Additionally, involving them in real estate investment activities, such as managing rental properties, can provide practical experience and exposure to real estate investing.
What is a Custodial IRA and how can it benefit my child?
A Custodial IRA can benefit your child by providing tax-deferred growth potential and can be opened with the child’s earned income. Earned income can come early in life, such as being a “model” in one of your business’ photos. It can be a traditional or Roth IRA, with potential tax deductions for contributions in traditional IRAs and tax-free withdrawals in Roth IRAs.
What is a 529 plan and how can it help save for my child’s education?
A 529 plan is an investment account that allows for tax-free growth and withdrawals for education expenses. It can be very beneficial in saving for your child’s education and also impact federal aid eligibility positively.