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March 19, 2021

The Best Investment Strategies For Teens (and Their Parents)

We often think of investing as an ‘extra’ that we can start doing when we have our finances in order, later in life. Investing is often synonymous with retirement, and who wants to think about that when there are student loans to pay, cities to explore, and friends to hang out with? We think about putting money into a 401(k) when we join the workforce or get a ‘real’ job.

The truth is that you can actually get started (or help your children get started) much earlier than that. Families can seek out investments for teens to help pay for college, get a head start on saving for retirement, and more. And in addition to helping save for a teen’s future, it has the added benefit of instilling financial literacy at a younger age.

Why encourage teens to invest

Take advantage of compound interest

If you’re familiar with investing and the stock market now, you most likely wish that you could tell your past self to buy stocks or real estate earlier in life. Without the aid of a time machine, the next best thing to do is to set up your family to invest early on. Thanks to compounding returns and investment strategies like DRIP (Dividend Reinvestment Plan), those who start saving for retirement at a young age are far more likely to have enough in the bank when they reach retirement age. People who invest a small amount early on (even $100 a month) can end up with more money than those who wait an additional decade and save a lot more money.

Pay for college

It is an unfortunate reality that more money equals more options and opportunities in life. While that may be a tough lesson to portray to a teenager, you can show them that saving up for college is a worthwhile endeavor. College is expensive, and the ramifications of using loans to fund your education follow you for years after you’ve graduated. By investing as a teen or encouraging your teenagers to invest, you can help set money aside to cover some or all of potential college expenses without going into debt.

As an intro to personal finance

It’s never too early to geek out about personal finance. There are many books for kids and teens on the subject, just because there are clear financial benefits to learning about personal finance at a young age. And in a time where financial literacy is severely lacking, this knowledge will be a huge advantage later in life.

An investing guide for teens

When it comes to investments for teens there are a number of great ways to get started:

Have Them Open Their First Checking Account

While not directly related to investment, this first step is crucial. It’ll help corral all the birthday, graduation, and holiday money into one pot (which you can divide according into buckets at most banks). Teaching them how to log in, keep their password safe, look at their balance and account activity will get the teen comfortable with the idea of money and investing. It will teach them financial responsibility by using a debit card and checks if they need to, and they’ll have to manage their balance (with guidance from you).

Open a custodial account

A custodial account is a brokerage account that an adult can open on behalf of a minor. These accounts are set up under the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). Parents and other adults can open the account, make contributions, and select investments. Then, when the child reaches adulthood (either 18 or 21, depending on the type of account), the account legally becomes theirs.

Anyone (parents, grandparents, other relatives and friends) can make unlimited contributions to a custodial account once it’s open. However, a person can’t contribute more than $15,000 per year ($30,000 for a married couple) in 2021 without triggering a gift tax.

Open a tax-free 529 account

A 529 account lets you save for college or other education related expenses on behalf of a child. There are tax advantages to a 529 plan: contributions aren’t subject to taxes and,  as long as the money is spent on appropriate expenses, you won’t pay taxes on the withdrawals either.

A 529 plan doesn’t have to be so restricted. Some expenses that qualify for 529 plan withdrawals include:

Open a custodial IRA

An IRA is a type of tax-advantaged retirement account available to anyone with earned income. As long as your teen has a job or a business where they earn income, they can contribute up to $6,000 (based on 2020 rules) into the account. The one catch is that the amount they contribute to the IRA can’t exceed the amount they earn. So if your teen earns $4,000 throughout the year, you as a parent can’t contribute $6,000 to their account.

Investing in the stock market

Once you decide the best vehicle to start investing for a teen in your life (or open multiple accounts based on your goals), do remember that many traditional investing options aren’t directly available to teens. Minors can’t be the primary owners on brokerage accounts, or directly buy stocks and most other investments.

You have to be at least 18 to start investing in stocks.There are a lot of investing apps that look perfect for teenagers with their colors and messaging, but you still need to reach 18 to participate. This restriction is a legal requirement specific to the investment industry, and there’s no way around it.

However, parents and guardians can make trades based on what the teenager wants to invest in. Be careful not to offer ‘advice’ that’s more of an ultimatum – most people learn from their own mistakes and love to experiment when they are first making decisions. It can be tempting to talk about low-cost index funds and ETFs, but it is a good exercise for teens to look at companies, news, and basic financial statements to pick a stock to invest in. Even if they pick companies they’re familiar with, like Starbucks or Apple, they’ll begin learning how to detect and differentiate value.

There are also newer options like Acorns’ Early service, which is free to all babies born in 2020 during the pandemic. It allows parents, guardians, and family members to set up a custodial account for children and even pick portfolio allocations. Once the child is legally an adult, the assets revert to them as the primary owner.

The bottom line

You can help set your children and teens to be financially savvy much earlier in life by setting up investment accounts for them. Popular investments for teens include custodial accounts, college savings plans, and retirement accounts – all of them allow you to allocate assets to contribute to the future success of your family in various ways.

But what’s even more important than the money itself is that you’ll set your teen up with life lessons that will benefit them forever. Personal finance is an important skill to have while growing up, so why not get your kids involved when they’re young!

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