Investing Advice by the Decade: Ages 11-20
Just as they do in their first decade of life, kids go through a ton of changes in their second decade. For boys, their deepening voices leave them thankfully less vulnerable to being confused for their mothers when they answer the phone! But more to the point for a financial blog post, kids undergo some very significant money-related changes between ages 11 and 20 as well.
Those who have studied what financial concepts compute in a kids' mind say the second decade of life is when they can more fully understand some of the most important investing ideas. Some kids can grasp these ideas even earlier. (See also: Investment Allocation by Age: Birth to 10 Years Old)
According to the National Endowment for Financial Education's (NEFE) brochure, Simple Steps to Raising a Money-Smart Child, between ages 11 and 13 they can understand what Einstein meant when he supposedly described compound interest as the eighth wonder of the world. Between ages 14 and 18, they can learn what stocks and bonds are all about, and they can appreciate the value of diversification.
Introducing Mutual Funds
That last point opens the door to discussions about mutual funds. While kids younger than 10 are much more likely to understand stocks than mutual funds, once they start moving through their second decade of life, mutual funds may make sense.
As a teaching aid, just pull up a description of a mutual fund using the website of a broker like Charles Schwab. Take a look at Schwab's S&P 500 Index Fund, for example. By clicking on the "Portfolio" tab, you can show your child what companies the fund invests in. She will recognize some of the top 10 holdings, such as Apple and Google. For as little as $100, she can diversify her investment across 500 leading companies whose stocks trade on the U.S. stock markets. That's pretty amazing. (See also: Tips From a Financially Savvy Teen)
Investing in an index fund is a fine way to mirror the market's return and can serve as a springboard for learning all sorts of foundational lessons about investing, like what the S&P 500 is, the historical returns of stocks vs. other asset classes, what is and what are the benefits of dollar cost averaging, the dangers of trying to time the market, and more.
First Jobs and Investing
As kids move through their second decade of life, their allowance often increases, and so do their opportunities to earn money outside the home. The Department of Labor's Youth Rules website explains what labor laws say about how many hours kids can work at various ages and what sorts of jobs they can hold.
Hopefully in the first decade of their lives you've instilled in your kids the habit of setting aside a portion of all the money they receive for savings. Now that they have more money coming in, they have the potential to sock away a lot more, and it makes all the more sense to get them involved in investing. (See also: 5 Things Your Teen Needs in a Back Account)
Custodial Investment Accounts
Even when their kids are still in the first decade of life, I encourage parents to open a custodial investment account for them (you need to be 18 or older to have an investment account in your own name). In the second decade of life, when a kid is likely to begin earning money, it's time to open a custodial IRA account, preferably a custodial Roth IRA. In order to qualify to make contributions to an IRA, you have to have earned income. You can open such an account at Charles Schwab with as little as $100.
One chief advantage to having your kids invest through an IRA is the tax benefit. If they did really well investing through a regular custodial account, they may bump up against the painful reality that they'd have to pay tax on their earnings.
OK, they'd have to have a lot of money in the account for a kid since tax would be due only if investment income exceeded $1,000, and it would take an account balance of over $14,000 to generate that much interest income, assuming a 7% return, but still.
With money invested through a Roth IRA, if your kid doesn't touch the account until age 59 and a half, there would be no tax due on the earnings. But kids don't have to wait such an unimaginable amount of time before they can access the money. Contributions may be withdrawn at any time for any reason without penalty. And even the earnings may be withdrawn without tax or penalty under certain circumstances.
Investing and College Financial Aid
Anyone who attempts to understand the rules and regs related to college financial aid should be forewarned that such attempts may cause confusion and will cause drowsiness. (See also: 5 Reasons Why Every Student Should Fill Out the FAFSA)
Regular Savings Reduces College Financial Aid
The financial aid formulas count a portion of an incoming student's savings and income against his or her family. So, a kid who heads to college not having worked a single day of his life, or not having saved any of the money he did earn, will qualify for more financial aid than one who has worked, saved, and invested.
Knowing this, some families may be tempted to have their kids not work because of the possible impact on financial aid. But the many benefits of work — diligence, responsibility, new skill development — will likely outweigh any of the drawbacks.
There is one last point about the financial aid formula that should be pointed out. Money in a retirement account does not count against the family. All the more reason to move from a custodial investment account to a custodial IRA when your kids start earning money.
The downside here is that if the money is taken out of the IRA to pay for school, it will be considered student income in the financial aid calculations. One way around that is to use such funds for the student’s senior year. The FAFSA form impacts the next year’s financial aid package. By using a student’s Roth IRA money for his senior year’s expenses, there won’t be a financial aid package next year to worry about.
Teaching your kids about investing is a great investment unto itself. A kid who enters adulthood knowing how and why to invest will be a very unusual kid — unusually well-positioned for success, that is.
Have you introduced important financial concepts to teens? What worked?