At a certain point, most teenagers reach an age where they stop simply bumming off their parents and make some money of their own. At this point, it’s a good idea to start teaching your teens about investing.
It’s a thrill to get your first paycheck, but it can be even more exciting to see money grow over time. Investing can be complex, but it doesn’t have to be. And no one expects a teen to become a billionaire hedge fund manager before age 20. But money lessons learned in your teenage years can be hugely beneficial down the road as you begin saving for important goals.
Let’s take a look at some things teens and their parents can do to get started.
Study an Investment Returns Calculator
One of the most powerful things you can do when introducing teenagers to investing is getting them to understand how much money they can earn over time.
There are many calculators online that will let you enter in the amount you plan to each month, the number of years you plan to invest, and the expected rate of return. For example, CalcXML.com is one website that has a variety of different financial calculators, but there are many others.
By way of example, a 16-year-old can learn how much they’ll end up with at age 63 if they begin with $500 and set aside $25 per month, earning an average annual return of 6%. Answer: More than $84,000, with roughly $70,000 coming from the increased value of their investments.
This exercise is especially important for teens because it’s clear that the best way to accumulate large sums is to start early, due to the power of compound returns.
Buy a Stock (Any Stock At All)
While it’s true that most people, especially teens, should avoid the practice of “picking stocks,” it can be a great education for someone starting out.
Consider letting a teen buy some shares of stock in a company of their choosing, and educate them on how shares go up and down, and why.
If the child is under age 18, the parent can be the one buying and selling the stocks, though they could also set up a custodial account.
A young person must first understand that stock investing, at its core, is owning part of a company. If the company does well, the investor does well, and vice versa. This is a powerful thing to learn.
It can be exciting to say that you are a part-owner of The Walt Disney Company, McDonald’s, or Coca-Cola. And it’s even more exciting watching that investment rise in value. (Wait until the get first dividend payment!)
If a teen is actually earning money, encourage them to set aside a certain percentage of their income to buy more shares.
Starting teens off with a few shares of stock will teach them the basic of the how markets work and how companies make money. It can also teach them the value of patience, as shares of stock may lose value in the short term, but usually go up over time.
And who knows? Maybe those few shares of stock now could result in millions of dollars down the road.
Invest in a Low-Cost Mutual Fund
Once teens get a basic understanding of stocks, they can begin investing in mutual funds. Mutual funds allow an investor to investing a broad set of stocks and spread out their investment risk.
The best options are funds that offer broad exposure to the stock market with very low expenses. Index funds, which are designed to mirror the performance of the S&P 500 and other stock indexes, are popular options. Vanguard is well known for offering these funds, and many other mutual fund companies offer similar products with low expenses. (Fidelity, for example, now offers index fund products with no expense ratios and no commissions.)
This is a straightforward way for teens to begin building a diversified investment portfolio and profit from the long-term, upward trend of the stock market.
Open a Roth IRA
Parents can start their children onto the path to retirement savings by opening a custodial individual retirement account. Arguably the best option is a Roth IRA, which allows any money you deposit to grow tax-free, as long as you wait until age 59 ½ to withdraw it.
A teenager may not understand the importance of saving for retirement, which may be 40 or 50 years away. This is an opportunity for you to convey the importance of saving for the long term, and the wealth-building power of investment returns over a large time horizon.
It’s important to note that most brokerages have minimum balance requirements to open accounts, so you may need to wait until your teen has built up some savings first. Additionally, all deposits must come from earned income (such as money from a job) as opposed to gifts.
Open a High-Yield Savings Account
As teens begin to earn money from their allowance and first jobs, they will get an introduction to banks. This is an opportunity for them to learn how interest rates work, and get a basic understanding of the value of compounding returns.
Since teens tend to be tech-savvy already, they will have no problem putting their money in an online savings account that pays a higher interest rate than their local brick-and-mortar bank. Popular options include Ally Bank, CapitalOne360, and CIT Bank.
These online savings accounts are designed to encourage saving. They often don’t allow you to withdraw money using an ATM card, and many won’t even let you write checks. Teens can deposit a portion of their earnings into this account and get started on the path to savings.
Start a Small Business
There is some risk in opening a business, so it’s important to start very small. You don’t want your teen blowing their entire allowance on a speculative venture. Instead, assist them in opening a lemonade stand, or perhaps a small Etsy shop. Teach them the basics of purchasing equipment or materials, tracking expenses, pricing, and logging revenue. There are many examples of teens who have gotten rich through entrepreneurship. But even if your teen isn’t going to be on Shark Tank tomorrow, they can learn a bit about how to make money through self-employment.