Investing for kids — How important is it? How would you go about introducing it to your little ones? Is it something that everyone can do or do you need a background in finance to even start?
Well, armed with the right information and a solid grasp of the basic principles, you can help your kids get in on the action. Even though it might not be an easy feat, the benefits alone will be well worth the journey.
So stay with us as we break down the most important terms, asset options, savings accounts, and much more!
Why Investing for Kids Is Important
One of the best ways to ensure your kids are set up for future success is to teach them about investing. In fact, investing is an incredible way to build wealth over time and the earlier someone starts, the better their chances are.
But that’s not the only benefit of investing for kids.
For starters, the practice can develop and nurture excellent saving habits. Once they’re taught at a young age, the payoff can be monumental.
Through investing, children can learn the value of money and how much hard work goes into earning every cent. Not only that, but they’ll also have to develop patience as there are almost no investments that yield instant results.
Earning Compound Returns
Over an extended period of time, compound returns can amount to big opportunities. To show the importance of starting early and not needing a lot of capital upfront, here’s a quick calculation.
Let’s say that you’re setting aside $5 each month, starting when the child is born, and up until their 18th birthday. You would have a grand total of $1,080. Even though that’s not a bad sum, here’s how much more it can improve.
Using the official Investor.gov calculator, those same five dollars over the same period of time will yield $3,032.84. The only difference? A 10% annual return on the investment.
Here’s another example: $50 per month until your kid turns 25 will get them $15,000. On the other hand, if you and your kid(s) were to take advantage of a 10% annual return, the total amount would be $66,944.52. That’s more than a quadruple reward for the exact same amount of money.
Taking the (Right) Risks
Life is full of risk, and there’s just no way around it. When kids participate in risky play, whether it be on the playground or while investing, they learn so much. By testing their boundaries in a safe environment, kids will get an increase in their self-confidence, risk management skills, and resilience.
And that’s why building risk tolerance with investing is so important. Just like in life, children can learn that there’s no one sure thing that will guarantee success and fortune. By having their own money on the line, kids can learn about these relationships and get a better sense of their own risk tolerance.
Just like risk tolerance, patience is a quality that all children can benefit from. By waiting and watching their assets slowly grow, children will get a much more realistic expectation of investing. What’s more, investing for kids teaches one crucial life lesson, and that’s that there is no such thing as a get-rich-quick-scheme.
Achieving Financial Literacy
We’ve potentially saved one of the best benefits for last, as achieving financial literacy is often the main reason parents start looking into investing for kids. Financial literacy plays a significant role in someone’s quality of life, and understanding that early on is crucial.
According to a survey done by Annuity.org, 60% of adults in the US reported that they don’t think that their retirement savings are good enough as they are. Also, 25% of adults say they don’t have a trusted financial guide, and 37% report that they’re just getting by financially.
Those, and many more statistics, paint a pretty bleak picture and the unfortunate events financial illiteracy could lead to. Getting into investing for kids early on and giving them the right tools can go a long way to rectifying the situation.
It could also help your children avoid unnecessary debts down the road, which are currently constraining almost 40% of Millennials in the US. On the other hand, a reported 25% of Gen Z say that their debts are preventing them from addressing financial priorities.
Understanding the Basics of Investing for Kids
Coming straight out of the talk about financial literacy, parents play one of the most crucial roles in a child’s education. However, a lot of parents say that they’re not confident enough to do it on their own.
To help you not miss out on such an important step, we’ve come up with a glossary of some basic investment terms that everyone, no matter how young or old, should know.
The Investment Glossary
An annuity refers to an insurance contract that financial institutions issue and distribute in order to pay out invested funds in a fixed income stream. It is a financial product that offers a guaranteed stream of income, usually for retirees.
Capital Gains and Losses
Capital gains or losses signify the difference between a person’s cost basis in an investment vs the amount that they sell it for. They can help you determine the rate of a return on investment (ROI). Also, capital losses can reduce the tax burden, while gains are subject to taxes.
When we’re talking about cash in investing, we’re not just talking about physical bills and cents that someone has in their wallet. Cash plays a key role in a diversified investment portfolio since it’s the money that is either in short-term investments or bank accounts.
Speaking of diversification, the proper definition is the process of spreading funds in a person’s investment portfolio across various assets. While investing, you can diversify across and within specific asset classes. It’s also a crucial component when building investment portfolios since it decreases risk.
Emergency funds refer to the money you have set aside in case of, well, an emergency. That’s the reserve to help cover any unplanned expense, and a general rule of thumb is to set aside enough to last you 3–6 months.
In the simplest terms, an interest rate is what it costs to borrow money. It’s usually based on your credit, as well as the type of debt you’re taking. Depending on the situation or investment, it can either work for you or against you.
It describes how easily you can, at any moment, convert your investments into cash. Essentially, all the cash you have, including the one in your bank account, is the most liquid as you can use it in an instant.
By contrast, the less liquid assets usually include the physical ones, e.g. vehicles or real estate. That’s because of the time you’d need to convert those assets back into cash.
Contrary to popular belief, an investment portfolio isn’t just the one account you’re using. It refers to the entire collection of investments, which includes:
One way to calculate your net worth and assess your financial goals is by looking at your portfolio as a whole.
We’ve already briefly mentioned risk tolerance earlier, but we wanted to expand on it a bit. It essentially describes the level of risk you or your child feel comfortable with when it comes to your investment portfolio. Now, keep in mind that it’s different from risk capacity because that signifies someone’s ability to take on risk based on their current financial standing.
An Individual Retirement Account or IRA allows a person to take advantage of withdrawals on their investments, as well as tax-free growth. What’s unique about Roth IRA contributions is that they’re made with income that has already been taxed. Once that happens, the money can’t be taxed again, not even if you withdraw it during retirement.
When a company goes public, all of its investors are issued shares. Those shares represent a single piece of ownership in that company. Of course, the more shares someone buys, the bigger their ownership becomes.
In addition to having a bigger stake in a company, having a high number of shares gives the investor the right to vote in shareholder elections. Also, shares have the potential for dividend payments, which is a great bonus.
A term that refers to equity investments, a single stock is pretty much the same thing as a single share. But the big difference between the two is that a stock can also describe the asset class as a whole. You should also know that the two types of stock you can buy are common and preferred.
Many private employers in the US offer a 401(k), which is a retirement account with certain tax advantages. It allows the employees to make contributions to an investment account, which are tax-deferred and grow while they’re in the company. Once the worker goes into retirement, the funds become taxable income to the investor.
Asset Options for Kids
When considering investing for kids and complete beginners, parents might want to look into easy-to-access assets. The following assets can be held both by the parents and by the kids.
Stocks are some of the potentially most fruitful, albeit risky, investment options for kids. Children can hold stock in various types of investment accounts, and potentially receive higher rates of returns (compared to other asset classes).
What’s more, finding a company that your kids can relate to or interact with can improve your chances of getting them interested in investing. Another thing to know about stocks is that the profit doesn’t only come from a company’s success. It can also come from dividends or cash distributions that the company makes to the shareholders.
That means that the ultimate holding power comes exactly from the stocks that both pay dividends and grow.
- Mutual Funds
We can’t talk about investing for kids without mentioning mutual funds as they’re essentially a pool of money. You see, while stocks are a solid investment, they can also be pretty risky. Companies fail every day, and when they do, their stocks plummet all the way down.
On the other hand, mutual funds, which are gathered from a bigger group of investors, are invested in a bigger group of assets. These are usually bonds, stocks, or a combination of the two.
One single mutual fund can have dozens (in some cases even hundreds) of stocks in its portfolio. It’s essentially helping cast a much wider net than buying stocks from a single company could.
It’s also important to note that investing in mutual funds contributes to diversification. And as we mentioned earlier, diversification is one of the cornerstones of investing for kids and investment portfolios.
- Exchange-Traded Funds
If you like the idea of investing in mutual funds but would like something even easier, let us introduce exchange-traded funds or ETFs. They’ve been on the rise over the past few decades, and there’s a good reason for it.
Now, both mutual funds and ETFs hold a diversified portfolio of bonds, stocks, and other investments. But unlike mutual funds, ETFs trade on the stock market during trading hours. That means that you can see what your ETFs are holding every day, and not just once per quarter.
Also, ETFs are usually index funds, which means they’re passively managed. As a result, they tend to be cheaper on average compared to mutual funds. Even if you want to get actively managed ETFs, they’d probably still cost less. ETFs also have certain tax advantages, which help their returns.
- Savings Bonds
When it comes to investing for kids, one of the most popular gift options among parents and grandparents is savings bonds. That’s because they’re basically a zero-risk financial product.
Savings bonds grow tax-free and are meant to be held for a long time. One thing to note is that when the kid tries to redeem the savings bonds, they’ll still have to pay federal income tax. (1)
Many parents looking into investing for kids also consider EE bonds, as they tend to be low-risk. They earn interest for 30 years, but Treasury Direct guarantees that any bonds bought will double in value during the course of 20 years.
We mentioned annuities earlier, but we want to delve more into how they work in the context of investing for kids. If you do decide on annuities, you’ll have a couple of choices to make.
For example, do you want the payment to start immediately, or do you want to postpone it to a later date? Also, do you want them to be paid out in a lump sum or would a series of payments work better?
Another important decision to make is whether you want to go for fixed or variable annuities. The difference is that the former pays out a guaranteed interest rate, while the latter is a bit riskier but can provide higher overall returns.
When it comes to investing for kids, many people also consider deferred annuities. They’re long-term investments that allow for the initial sum of money to grow.
Earlier on, we talked about the prospect of simply putting aside cash without investing it. Cash has the smallest upside compared to other assets because it won’t grow, at least not on its own. Not only that, but due to inflation, it’s an asset that can lose its purchasing power over time.
With that said, if you’re looking to give a kid something, it’s potentially the easiest and most flexible option. Children can use cash to buy something for themselves, or even potentially make an investment of their own.
One thing to keep in mind if you’re gifting a child cash is that there are certain limits. To avoid paying the tax gift, you can give up to $16,000 per year, per person. However, married couples can combine their exclusions if they want, and gift up to $32,000.
How to Open a Savings Account for Kids
When it comes to opening a savings account for kids, the process isn’t much different than opening one for a grown-up. Parents or legal guardians need to be the ones opening the account.
First, you should start looking into where you want to open the savings account. When choosing the best business for your investments, reviews and reputation, investment options, features, and fees are some things to consider.
Also, since an adult is opening the account for a child, they’ll need certain information to get started:
- The child’s name, birthday, and social security number
- Picture identification of the account holder
- Social security number of the account holder
- Address, email, and phone number
- An initial deposit (will vary depending on the business and type of account)
Finalizing the account will depend on the business itself. But whether it’s a bank or an app, the process is usually entirely guided and the company should take you through all the steps.
As we said before, some businesses will require an initial deposit upfront. The minimum amount will depend on the business itself, but the maximum to give for a tax-free gift is $16,000 (or $32,000 for a married couple).
Account Options for Kids
When it comes to investing for kids, you’re going to have to consider a lot of different account options. So depending on your family’s financial needs and wants, here are the most popular accounts to consider.
Custodial accounts allow an adult to maintain financial assets for someone else, in this case, a child. In addition to stocks, bonds, cash, ETFs, and mutual funds, custodial accounts can also hold annuities and life insurance policies.
Once a child reaches the age of maturity stipulated in the account, which is usually 18, 21, or 25, the account, and all the assets in it, revert to them. As the new owner, they can withdraw money from the account at any moment.
Uniform Transfers to Minors Act/Uniform Gifts to Minors Act (UGMA/UTMA) Accounts
Uniform Transfers to Minors Act/Uniform Gifts to Minors Act or UGMA/UTMA accounts are types of custodial trust accounts, and children can only access them once they turn 18 or 21.
On the face of it, UGMA and UTMA accounts seem similar. They’re both set up by parents, guardians, or relatives, who serve as custodians and are used to hold financial assets.
But the main difference between the two is in the types of assets they can hold. UGMA accounts can only hold purely financial assets. These include:
- Life Insurance policies
- Mutual funds
If a UGMA account is opened through a stockbroker or bank, those who contribute to it don’t fall subject to annual contribution limits. It’s also important to note that once a financial gift is deposited into a UGMA account, it can’t be taken back from the minor. (2)
On the other hand, UTMA accounts can hold any type of property. That includes all the assets we’ve mentioned for UGMA, but real estate and other property, as well. For example, a UTMA account can hold a deed to a home, fine arts, collections, etc.
If your kids are between the ages of 13 and 17, they can open a custodial brokerage account.
They have little to no fees while providing a buy-and-hold strategy for long-term investing. With that said, a parent or custodian must be involved.
Brokerage accounts allow for purchasing of stocks, bonds, cash, ETFs, and mutual funds for a variety of investment options. If your kids decide to purchase stocks for a brokerage account, you can involve them in the selection process.
One drawback of owning a brokerage account is that, unfortunately, there are no tax advantages to it. But when it comes to investing for kids, doing it with your child could prove to be the best gateway to later financial literacy and stability.
If you want to have more control and oversight of your child’s account, consider a joint brokerage account. An adult has to open an account in their name, but kids and other family members can contribute to it.
Individual Retirement Accounts or IRAs allow you to set aside your child’s income toward your retirement. The two types of IRAs are:
- Traditional IRA
- Roth IRA
A traditional IRA allows you to set aside pre-tax cash that invests over time, which means the tax deduction is immediately available. However, when your child wants to withdraw money down the line, they’ll have to pay taxes. (3)
On the other hand, Roth IRAs allow for investing after-tax money, but more on that in a second.
You should also know that both the traditional and Roth IRA accounts have an annual contribution limit. The limit is equal to the lesser of your income, which for 2022, has been $6,000. However, those over the age of 50 can also contribute an additional $1,000 per year.
The types of assets you can hold within an IRA are the same as the ones for Custodial or UGMA accounts. These include stocks, bonds, cash, ETFs, and mutual funds.
Custodial Roth IRAs
A custodial Roth IRA is a type of account specifically designed to save a child’s money for retirement. It has tax advantages, which means contributions are made with after-tax money. Essentially, the funds deposited in the account will grow tax-free and can be withdrawn tax-free in retirement.
Earnings can also be withdrawn tax-free five years after the account has been opened and if one of these conditions has been met:
- Reaching the age of 59.5
- A qualified first-time home purchase
Since it is a custodial account, an adult has to manage it until the child turns 18 or 21, and can then take over the account.
One thing of note here is that there are gifting limits and they cannot exceed the child’s earnings. So if a child has earned $1,000 during the year, they can’t receive more than $1,000 as a gift. Keep in mind that the annual maximum contribution per year, per child, is $6,000.
529 Education Savings Plan
When it comes to investing for kids and planning for their future and education, many parents and guardians consider a 529 plan.
Unlike with the IRA, there are no contribution limits, and everyone and anyone can donate to the savings plan. When it’s used to pay for education expenses, the 529 plan allows you to contribute after-tax money, which will grow tax-free.
The 529 plan is set up to cover the cost of formal education while having a minimal impact on financial aid eligibility. There are two types of 529 plans you can set up:
- An education savings plan
- A prepaid tuition plan
An education savings plan, sometimes known as a college savings plan, works similarly to a Roth IRA. It allows you to invest after-tax money into mutual funds. Even though the contribution will grow tax-free, the growth rate will depend on how well the investment options in the account perform.
On the other side, we have a prepaid tuition plan, which will allow you to contribute a part or the entire amount to cover public, in-state college costs. You can also convert the money to go toward an out-of-state or private college.
Withdrawals for both types of plans are tax-free, as long they’re used for qualified education expenses. You also might be eligible for a return on a state income tax or for a tax credit.
Coverdell Education Savings Plan
The Coverdell Education Savings Plan also serves to pay for a child’s educational expenses. Both the contributions and withdrawals are tax-free for this plan, as long as kids are using them for things like college tuition or books.
But that’s where the similarities between the 529 and Coverdell plans end. Unlike the 529, Coverdell accounts have very strict contribution limits. You can’t contribute more than $2,000 per year, per beneficiary.
The only way around the contribution limit is if your household qualifies as a higher-income one. That means you have a modified adjusted gross income (MAGI) between $95,000 and $110,000 annually. (4) For those who file a joint return, like married couples, their MAGI can be anywhere between $190,000 and $220,000.
Attainable Savings Plan (ABLE)
If you have a child with disabilities, you should look into an Attainable Savings Plan or ABLE. For the child to be eligible, they have to already be receiving benefits under Social Security Disability Insurance (SSDI) and/or Supplemental Security Income (SSI). (5)
If they’re not receiving either of those benefits, they can still be eligible if they’re certified disabled or blind by a licensed physician. Another stipulation for ABLE eligibility is that the disability had to have started before the age of 26.
There’s a range of professionally managed investment portfolios that you can consider as investment options under ABLE. Also, you can make withdrawals at any time, without owing any federal tax income, as long as the money is used for qualified disability expenses.
How to Get Kids Interested in Investing
Nowadays, learning about investing isn’t only left for adults. And a good thing, too! But when it comes to investing for kids, getting your children interested in what can be a pretty dry topic can be challenging. But we’re here to help with our top suggestions on how to spark curiosity.
If your kids love reading or being read to, you can pick up some educational books on investing, written specifically for them. They can help them learn about finances, money management, financial literacy, and more.
The host of the Financial Grownup podcast and a certified financial planner, Bobbi Rebell, recommends the Startup Squad by Brian Weisfeld and Nicole C. Kear. You can also pick up “One Cent, Two Cents, Old Cent, New Cent” by Bonnie Worth, recommended by the deputy editor for Romper, Janet Manley.
For the kids who want something more interactive, there are quite a few financial and investing games out there. They teach all sorts of lessons, including budgeting, interest rates, stock trading, and more.
For the younger gamers, there’s the Stock Market Game, which gives kids $100,000 in virtual money. In it, they can compete in teams or as individuals, while learning about investing through a series of lessons. The game is supported by the Securities Industry and Financial Markets Association (SIFMA) Foundation.
Kids who are more well-versed in investing for kids can get access to the game How the Market Works. There’s a $100,000 virtual cash to help them build a portfolio. Parents or even teachers can create their own custom contests with personalized commission structures, security types, dates, and more. The game also gives access to free investment lesson plans.
One of the most interactive ways to get children interested in investing is through apps, like BusyKid. Parents and children of all ages can learn financial literacy in a fun and engaging way.
Investing apps can teach kids about financial responsibility, the power of charitable giving, and more. With the right app, your little ones can develop a portfolio in the comfort of their own home.
But one of the biggest upsides of using investing apps is parental oversight. While kids learn about different financial topics, parents can see how they’re progressing and what they’re spending their money on.
With the BusyKid app, we make investing fun, engaging, and interesting. And it’s not just for the youngest members of the household. BusyKid is an app for the whole family that engages, empowers, and motivates. It teaches money responsibility and management, all the while developing a portfolio.
Some of our more popular features include a chore chart, a list of charities to donate to, rewards, bonuses, and so much more. There are, of course, parental approvals as well, along with a history of all transactions and paydays.
In an effort to empower kids to spend responsibly, we’ve created the BusyKid Visa® Spend Card. It gives kids the freedom to spend anywhere Visa is accepted, while parents monitor every transaction.
So the question isn’t Why BusyKid? It’s Why are you still not using BusyKid?
Investing for Kids — The Final Tips
Investing for kids, as well as investing in general, is as challenging as it is rewarding. When you’re investing with or for your kids, you’re better preparing them for the future.
Not only will it teach them responsibility and commitment, but they’ll also learn about setting goals and seeing the bigger picture.
But if you’re still struggling with engaging your little ones, consider diversifying your approach. Instead of just sitting them down, and distilling all information, try BusyKid, where their financial future is available to them at the palms of their hands.