How to Teach Your Child About Investing

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Author: Alicia Carl

As your children become more familiar with financial concepts and the use of money, it’s wise to educate them on investing and the know-how that can put them on the path to financial security.

You can do this by regularly involving your children in discussions about money, or periodic household financial reviews.

Below are steps to follow if you want to set your children up for future success:

Open an Investment Account For Your Child

The first step in getting your children started is opening an investment account in their names. There are several account options for children of different ages, each with its unique perks. Here’s an overview of your options:

Custodial Trust Account

A custodial trust account, which is also called the UTMA or UGMA trust account, is opened by an adult on behalf of a child. The adult will serve as the account custodian until the child reaches a certain age, usually 18-25years. 

The custodian can invest in some assets, such as bonds, stocks, and index funds. Custodial trust accounts are funded by the after-tax income. 

Custodial Roth IRA

Children with a paid part-time job can qualify for a custodial Roth IRA. The Roth IRA account is a good option for managing retirement savings. The adult who opens the account handles the money until the child reaches a certain age, usually 18 and 21 in some states.

Earnings in this account are tax exempt if they withdraw after 59 ½. However, as deposits are funded with after-tax money, they can be withdrawn penalty-free to cover miscellaneous expenses and qualified educational bills.

529 Education Savings Plan

The 529 tax-advantaged plan is an account that allows you to save for your child’s future education. Unlike other tax-advantaged saving accounts, your child’s 529 account has no income limits for contributions.

With this type of savings, your money grows tax-free, and withdrawals are also tax-free provided that you intend to spend it on qualified tuition expenses. You may also be eligible for tax reductions on deposits depending on your state of residence.

Brokerage Account

Some brokers permit children to set up a brokerage account, giving them full autonomy over their money, earnings, and investment decisions.

Equipped with fractional shares, your child can begin investing with as little as a Dollar. However, brokerage accounts are taxable, so they must pay taxes on any capital gain or income held.

Teach your Child The Basics of Investing

Once children develop an understanding of money management, it’s a sign to teach them more about investment.

To begin, introduce the basics of investing. Explain the concepts of stocks, bonds, and other investment options. 

Unlike a savings account, stocks are variable return, variable risk investments. You can further explain the risk involved (stock value can rise and crash) – depending on the profitability and growth of the company.

Gifting stocks is another method you can use to aid their learning. Some brokers allow you to gift fractional shares to your children. Allowing your children to make independent decisions might be helpful because they gain experience and learn from mistakes along their financial journey.

Begin With Saving and How to Handle Money

Before you start investing with your kids, it’s best to tackle the basic financial concepts like spending and saving. 

Create a simple budget, and explain its role and importance in every financial plan. Once you scale budgeting and spending, you can proceed to more in-depth concepts.

Let your Child Invest

Eventually, you would want your child to buy their stocks and gain firsthand experience with would investing. By the time they have enough funds to invest, they would have reached minimum age – but with your guidance, not supervision.

Instead of putting it all into bonds or stocks, we advise that they invest one-third in each and store a third in savings. It will enable your child to compare the nature and returns of different types of investments.

If your child cannot afford to partake in this learning process, you can either:

a. Personally fund a small brokerage account for your child to invest in

b. Create a model portfolio of bonds and stocks that your child wishes to buy in the future. 

However, using the model where no real funds are at stake will require you to find innovative ways to entertain your child’s interests.

Final Word

The earlier you introduce your kids to investing, the earlier they begin developing proper financial habits and building wealth over time. The experience of growing their investments, plus losing and gaining money will be invaluable as they mature into adults.

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