How to Teach Your Kids About Investing

In earlier posts, we’ve talked about Teaching Children How and Why It’s Important to Save Money as well as Teaching Kids to Automate their Savings.  Helping kids understand that setting aside the money you earn rather than spending it immediately is an important first step on the path to financial literacy.

Once your child has established some savings, investing is the next step in helping your child become financially secure and build long-term wealth.  

3 Savings Concepts to Tackle First

Before you jump into a conversation about investing:

1. Be sure your child is already saving money in an FDIC insured institution and has mastered the concept of a debit card.

2. Spend some time teaching your child how to access their account online as well as how to read and double check bank statements. Explain that the small amount of interest they earn in a savings account is their money “at work,” and that there are other ways that their money can earn significantly more for them.

3. Be sure your child understands the difference between a checking and a savings account. Primarily, you want kids to grasp that savings accounts are for money they don’t plan to spend anytime soon. It’s money they want to keep for the future. Checking accounts, on the other hand, are for money they plan to spend on things like movies, gas, toys – whatever guidelines you’ve established in your house.

Next you can teach them how their money can earn more than the current measly interest rate their bank or other savings institution is paying. It’s time to talk about investing! 

Where to start? First, ditch the complexity. You want to encourage your child to invest, not overwhelm him or her. So, keep it simple. Here are a few basics you might address.

Stocks vs. Bonds

Stocks

Stocks are essentially a way for your child to buy some amount of ownership in a company. Unlike low yield savings accounts, however, stocks are an investment that comes with risk. When they sell them, they can earn a lot more than a savings account if the stock price has risen since they bought it. But be sure they understand that stocks can go down in value, in which case they can lose money.

Bonds

Bonds are another way your child can invest money but, unlike stocks, a bond doesn’t buy your child a piece of company ownership. In contrast, institutions like the government, banks, and companies, offer bonds when they need to raise money. 

In essence, your child is borrowing that debt. Because they’re generally backed by banks or the government, bonds are a lower-risk investment than stocks. The flip side of that coin is that your child’s money will generally earn less from a bond investment than a stock investment (although if the stock they choose tanks, that might not be the case.)

Explaining to Your Child How to Invest in Stocks and Bonds

When your child opens a brokerage account, they take money out of their savings account and deposit it into an investment account. They then choose what type of investments they’re interested in.

One easy way to get started is for your child to open an investment account with their current bank. If that’s not an option, there are plenty of reputable online brokerages to choose from. 

Introducing Basic Investment Options to Your Kids

As we mentioned above, stocks and bonds are the most common investment vehicles. But you can invest in specific stocks and bonds or in vehicles that group them together, like mutual funds or ETFs (exchange traded funds). Here are a few to discuss as your child begins their investing journey.

1. Specific stocks. Buying a specific stock means you’re buying a small part of a particular company. This idea often resonates with kids because they like the idea of buying a part of a company that interests them, like Disney or Facebook. 

   To make the idea more relatable, you can share with your child a few of the stocks in your own portfolio that they’ll be familiar with. 

   When I was a little girl, my parents owned BP stock. My dad explained the concept of stock purchase and company ownership to us. Then, when the BP stock paid a dividend, he took us to the gas station and filled our tank with that dividend money. I never forgot that tangible lesson in the benefits of stock ownership!

2. Mutual Funds. When kids invest in a mutual fund, they’re buying a pre-bundled package of stocks that gives them a small piece of ownership in several different companies. Make sure your child understands that people are paid to manage these funds, which means they make trades and purchases to meet the funds’ goals based on their industry knowledge. They’re a good investment for people who want to “set it and forget it.”

   There are several different types of mutual funds, like money market and index funds. When your child is ready to take this step, be sure to research which type of fund best suits their goals. Exchange Traded Funds (ETFs) are another option but we think mutual funds are an easier entry point for kids who are starting to invest.

3. Debt. There are several types of debt in which you can invest, among them these four: Certificates of Deposit, (a bank’s debt), Corporate bonds (a company’s debt), Municipal bonds (a city or state’s government debt) and Treasury bonds (federal government debt).

In each of these cases, when you purchase the bond, you are lending money to an institution that wants to raise money. 

This type of investment is often called a fixed income investment because you loan your money with the intention that you will be repaid a fixed amount in a fixed time period of time. 

For example, if you purchase a 20-year Treasury bond, you are loaning that money to the U.S. Government for 20 years. During that time frame, the bond will earn periodic interest and, when it matures in 20 years, the owner is “paid back” the principal amount (also called par amount, or face value) of the bond.

Investing Takeaways for Your Child

As you have these conversations about investing, a few primary concepts you want kids to understand are:

1. Investing is a critical component of building wealth. 

2. There are many ways to invest and all of them involve setting aside some portion of savings to allow your money to earn more for you. 

3. There is a risk-reward relationship to every investment.

4. Investing is a long-term strategy, not a short-term, get-rich-quick scheme.