As soon as kids build up savings, they must deal with decisions on what to do with the money. Their focus might revolve around what toy they want to buy. But rather than helping them buy the latest toy on the market, parents should see this as an opportunity to teach their children that money is more than just a tool to buy things.
When kids begin to learn the lessons of investing at an early age, they also learn the pitfalls and consequences that come with poor financial and investing decisions. More importantly, they get an early opportunity to build wealth on their own. As adults, they can go on to make prudent financial decisions and wise investments that will guide and benefit them throughout their lives.
- Why You Should Start Investing With Your Kids
- How To Open a Brokerage Account for Your Child
- How To Teach Your Child About Investing
Why You Should Start Investing With Your Kids
We all know today’s kids will someday head households of their own. Failing to prepare kids for this role could create issues in the future, as investing will likely become the vehicle by which they build wealth and finance future needs.
Your financial situation affects nearly every aspect of your child’s life. It determines the neighborhood where they live, the school they attend and the clothes they wear. Parental guidance is the key to a child learning where they have come from and what it takes to maintain a lifestyle.
Because children often develop their attitudes about money in childhood, your personal situation influences your child’s financial future. Hence, improving your finances by paying down debt and sticking to a budget could also help your children. You might even include your children in financial discussions. As they begin to see your budget limitations and goals, they can better understand how to limit spending and set financial goals for themselves when the time is right.
Having a family comes with multiple financial goals — saving up for a house, sending kids to college and retiring comfortably, for example. Meeting these goals can be difficult for those who don’t have investment returns to tap into.
But parents can use their own struggles as an opportunity to teach their kids to start investing early. Whatever life path these kids take, they’re likely to have many of the financial goals you’re working toward now. As they see you pay off debts and build savings for their education and your retirement, they have an example for creating the financial stability that can bolster their future.
Teaching Children About Financial Literacy
In a world where pensions have become scarce, it’s imperative that children learn investment skills. Yet the overwhelming majority of kids will finish school never having taken a class on personal finance, let alone investing. The Consumer Protection Financial Bureau found that only about 10% of 15-year-olds were rated “top performers” in financial literacy.
Parents teaching their kids should keep it simple. First, focus on helping your kids create a budget, with part of that budget going toward savings. After they’ve built their savings, teaching them about investing is a critical next step.
Children are well positioned to take advantage of the power of compound interest. Compound interest is the interest calculated on the original principal and past returns. For example, at a rate of 5% annual interest, $100 will grow to $105 over one year. The next year, the depositor will earn interest on $105, resulting in a $110.25 balance after two years without any additional investment. That might not sound significant, but starting early offers exponentially higher returns.
In 2017, CNBC determined that the S&P 500 had delivered an average annual return of 9.8% per year over the previous 90 years.The table below shows how relatively modest but early investments grow when that 9.8% return is reinvested year after year:
|Growth in Retirement Savings|
In comparison, someone who invests $3,000 per year for five years starting at age 50 will have only about $46,060.
Kevin O’Leary of TV’s “Shark Tank” taught his children about compounding using a glass piggy bank, adding a few pennies to it each night. His children quickly learned that money makes money. Such knowledge not only empowers children with a powerful tool, but it also allows them to fund their retirement with substantially less investment than those who start late.
One way children can learn investing is to have their own brokerage account. Although many free options and investment apps exist, an account that caters to beginning investors is more suitable for children. The type of account needed depends on the child’s income and their investment goals. In most cases, you or another trusted adult can act as the custodian of an account opened in your child’s name.
When a child has no income, a Uniform Gifts to Minors Act account or Uniform Transfers to Minors Act account might be a good option. A UGMA account allows an adult to give cash or securities to a minor. The funds are managed by an adult chosen by the donor or a custodian.
The UTMA also involves assets given to a minor and managed by a custodian. But UTMA accounts involve a broader definition of assets. In addition to gifts covered under UGMA, UTMA assets may include real property. The minor can claim full control of the account once they reach majority status, such as the age of adulthood. That specific age varies by state.
Children who earn income can contribute to an individual retirement account, as this kind of account has no minimum age requirement. Like with a UGMA account, an adult will manage the IRA account until the child reaches majority status.
Having the right financial advisor can be a critical component of financial success. A good place to start your search is with GOBankingRates’ Best Brokers of 2020 rankings, which include several categories, including online brokerages and robo-advisors.
In the event you want to work with an advisor, the most important criterion is that the advisor is a fiduciary — someone required by law to put clients’ interests above their own — who gets paid a fee for their service rather than a commission on sales. One such type of advisor is called a certified financial planner. CFPs must meet standards of ethics and competence to earn and retain that designation. The National Association of Personal Financial Advisors also designates advisors who work on a fee-only basis. Such guidance can not only grow a child’s wealth with the protection of the principal in mind, but it can also give a child a head start on the path to financial success.
Learn More: What Is a Fiduciary Advisor?
Learning the basics of investing can give your kids an advantage as they increasingly take on adult financial responsibilities. Because a child must first accumulate the funds to invest, parents should start by opening a savings account on their child’s behalf and teaching the child to divide their funds between money they can spend, money they can donate and money they’ll save. Once the child has enough savings put aside, it’s time to open a brokerage account and start investing.
Although the invested funds could go into any vehicle the child can afford, stick with long-term investments as opposed to risky practices like day trading. This might entail a money market or savings bond and could eventually lead to a foray into the stock market, where you can look for exchange-traded funds, index funds or mutual funds with diversified holdings and track records of consistent growth.
Whatever the investment choice, learning early is critical. With these lessons, children can become adults who know how to accumulate wealth by investing their savings in ways that minimize risk and allow them to enjoy the benefits of a secure financial future.
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