Introduction to Investing at a Young Age
Investing is an important life skill that can help secure a better financial future. The earlier one starts investing, the more time their money has to grow through the power of compound interest. But how old do you have to be to start investing?
The good news is that there is no legal minimum age requirement for investing in the stock market. Even young children can get started with investing through investment accounts designed specifically for kids. Introducing investing concepts early can help build financial literacy for children that will benefit them throughout their lives.
Why Start Investing Early?
One of the biggest advantages of investing at a young age is the ability to harness the power of compound interest over a long time horizon. When you invest money, it has the potential to earn returns. Those returns can then be reinvested to generate even more returns. Over many years and decades, this compounding effect can lead to significant long-term growth in the value of the investments.
For example, if you invested $1,000 at age 10 and earned an average annual return of 7%, by age 65 that initial investment would have grown to over $140,000 without adding another penny. The earlier you start investing, the more time your money has to compound and grow exponentially.
Benefits of Financial Literacy for Children
Beyond the financial benefits of long-term investing, teaching kids about money and investing from a young age provides valuable life skills. Understanding basic financial concepts like budgeting, saving, and investing helps children make smarter decisions with money as they grow up. It sets them on a path to financial responsibility and independence.
Opening investment accounts for kids with parental guidance creates teachable moments. Children can learn firsthand how the stock market works, the companies they can invest in, and the risks and rewards involved. These lessons carry forward into adulthood, promoting better saving and investing habits over a lifetime.
Types of Investment Accounts for Minors
There are several types of investment accounts available for kids to start investing despite their young age. The most common options include:
- Custodial investment accounts
- Brokerage accounts for minors
- 529 plans for education savings
- Roth IRA for minors
Each account type has its own features, benefits, and considerations. The right choice depends on factors like the purpose of the account, tax implications, and level of control.
Custodial Investment Accounts
Custodial investment accounts are one of the most popular options for minor investing. These accounts are opened and controlled by an adult custodian, typically a parent or guardian, on behalf of the minor.
The custodian makes all the investment decisions and manages the account until the minor reaches the age of majority in their state (usually 18 or 21). At that point, the assets are turned over to the child’s control.
The two main types of custodial accounts are:
| Uniform Gifts to Minors Act (UGMA) Account | Uniform Transfers to Minors Act (UTMA) Account |
|---|---|
| Can hold cash, securities, insurance policies and annuities | Expands on UGMA to also allow real estate and alternative investments |
Custodial accounts offer flexibility – the money can be used for any purpose that benefits the child, not just education. However, any income generated may be subject to “kiddie tax” rules.
Brokerage Accounts for Minors
Some online brokers offer the ability for minors to open their own brokerage accounts with parental permission. These function similarly to standard brokerage accounts but often have features tailored towards young investors.
For example, Fidelity’s Youth Account allows kids aged 13-17 to buy and sell stocks, ETFs, and mutual funds. There are no account fees or minimum balances. Educational resources are integrated to help teens learn as they invest.
529 Plans for Education Savings
For money specifically earmarked for education costs, 529 plans provide a tax-advantaged investment vehicle. Contributions grow federal tax-deferred and can be withdrawn tax-free for qualified education expenses like tuition, room and board, and textbooks.
The account owner, often a parent or grandparent, maintains control of the funds. But the child is named as the beneficiary. If the child doesn’t need all the money for school, the beneficiary can be changed to another qualifying family member.
529 plans are administered at the state level, so specific rules and investment options vary. But in general, they provide a way to save and invest for a child’s future education.
Roth IRA for Minors
If the child has earned income from a job or self-employment, another investment account option is a custodial Roth IRA. Though retirement seems far off for kids, starting to save in a Roth IRA at a young age provides decades of tax-free growth and compounding.
There is no minimum age to open a custodial Roth IRA. The only requirement is that the annual contributions cannot exceed the child’s earned income for the year. So if a child earned $2,000 from a summer job, that is the maximum that could go into their Roth IRA.
The account is managed by the adult custodian until the child reaches the age of majority. All assets are then transferred to the child’s control.
Steps to Start Investing for Minors
Opening an investment account for a child is a fairly straightforward process. Here are the key steps:
Selecting the Right Account Type
First, decide which account type is most appropriate based on the goals for the money. Consider factors like:
- Purpose (general investing, education savings, retirement)
- Account ownership and control
- Tax implications
- Investment options and flexibility
For general minor investing, custodial accounts and youth brokerage accounts are usually good options. Education and retirement savings have specialized accounts like 529 plans and Roth IRAs.
Opening the Account
The specific process varies slightly by account type and provider. But in general, to open an investment account for a minor you will need to:
- Choose a provider (bank, brokerage firm, investment company)
- Provide personal details for the custodian and child (e.g. name, address, SSN)
- Complete a new account application
- Fund the account through bank transfer, check or existing account
Many institutions allow you to open accounts online in just a few minutes. Others may require physical paperwork. The adult custodian will need to sign all documents.
Choosing Investments
Once the account is open and funded, it’s time to select investments based on factors like:
- Time horizon (when will the money be needed?)
- Goal for the funds (growth, income, capital preservation)
- Risk tolerance (comfort with volatility)
For young investors, focusing on growth-oriented investments like stocks or stock funds often makes sense given the long time horizon. Stock index funds provide broad diversification to mitigate risk compared to individual stocks.
Funds may have minimum investment thresholds, so account for this when choosing. Many brokers also offer fractional shares, allowing purchase of portions of pricey individual stocks.
Setting Up Regular Contributions
To tap into the power of long-term compounding, establish a cadence of regular investing. Many brokers allow you to automate recurring transfers from a bank account.
Even small amounts add up over time. For example, automatically investing just $20 per week will grow to over $54,000 in 18 years at a 7% annualized return. The key is to invest consistently over a long period.
Risks and Considerations
While investing for kids provides huge opportunities to build wealth and financial literacy, it’s not without risks. It’s important to understand what you’re getting into before diving in.
Understanding Market Risks
Investing always carries the risk that you could lose money, and that applies to accounts for minors too. The value of stocks, mutual funds, and other securities will fluctuate over time. There is no guarantee of positive returns, especially in the short term.
Diversification – spreading money across many investments – helps manage this risk. Holding a mix of different stocks or stock funds provides a buffer if some perform poorly. The old adage “don’t put all your eggs in one basket” applies to investing too.
The Role of Parental Guidance
Parental involvement and oversight is key to successful investing for minors. In custodial accounts, the adult custodian calls the shots. But it’s a good idea to include the child in the process as much as possible.
Explain the investments you choose and why. Show them account statements. Teach by doing. Over time, give them increasing autonomy in selections as their knowledge grows. The goal is to prepare them to take full control when they reach adulthood.
Educational Resources for Young Investors
Building financial literacy for children goes beyond just opening an investment account in their name. Ongoing education helps them understand what they own and why, preparing them to manage money as adults.
Books and Online Courses
Numerous books and tutorials break down investing concepts into kid-friendly terms. Look for resources from reputable sources aimed at teaching personal finance basics like:
- Compound interest
- Stocks and bonds
- Risk and return
- Portfolio diversification
- Financial goal-setting
Popular picks include The Motley Fool Investment Guide for Teens, How to Turn $100 into $1,000,000, and Stock Market Investing for Beginners.
Technology and Investment Apps
Today’s kids are digital natives. Engaging investing lessons often come through a smartphone or computer. Many youth investing platforms have built-in educational features.
Stockpile, for one, offers kid-friendly lessons and email stock challenges. Investing platform CubeWealth gamifies investing for kids with lessons disguised as short animated video “missions”. The goal is to make investing education entertaining and interactive.
Using technology they’re comfortable with increases kids’ involvement with their investments. Apps, simulators, and games all disguise learning as fun.
Conclusion
You’re never too young to start investing. Getting kids involved in investing from an early age – via a brokerage account for minors or custodial account – helps them harness the power of compounding over the long term.
More than that, investing for minors builds comfort with money and financial literacy that lasts a lifetime. Under parental guidance, they learn investing fundamentals firsthand through the risks and rewards of their account. Start small, make it fun, and let the magic of compounding work – your child’s future self will thank you.
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