Helping teens invest helps them get a head start on their personal finances. Of course, teens can decide how much risk they want to take, but even conservative investments can help set teens up for a successful financial future.
Here’s what you must know to help your teen get started.
Can Teens Really Start Investing?
It might sound crazy that teens can invest. After all, it’s risky, right? The good news is that teens can invest. The even better news is that they can’t do it on their own, at least legally.
Instead, parents, guardians, or another trusted adult must be on the account with teens and monitor or execute the trades. So teens can invest, but it’s under the guidance of a trusted adult.
This, of course, doesn’t mean they won’t lose money; anyone can lose in the market, but they’ll have the guidance of a knowledgeable adult helping them.
Teens get the benefit of earning compound interest by investing young, but they also have their parent’s guidance to help them learn investing basics so they enter adulthood ready and willing to invest more.
Benefits of Investing for Teens
Why should teens invest money rather than just opening a savings account?
1. Chance for Great Returns
The answer is the same as for adults; there’s a chance for greater returns. I didn’t say a guarantee because there’s never a guarantee. But, with risk comes reward, and helping teens understand that can help them reach their financial goals.
2. Compound Interest
The largest benefit of teens investing early is compound interest. Any money they invest now has many years to continue earning interest, so eventually, their interest earns interest. So the longer teens keep their money invested, the more time the money will work for them.
3. Financial Literacy
Another great reason for teens to invest is to learn financial literacy. Making investing a natural part of their lives helps alleviate some of the personal finance stress most adults feel. Helping your child learn the ropes early on will help them feel confident in their investing abilities when they’re on their own.
According to Standard & Poor’s report, only 57% of adults are financially literate. Giving your child the gift of financial literacy gives them a head start in life.
How to Start Investing as a Teen
Investing as a teen doesn’t have to be complicated. As an adult, you can help your child learn the ropes at the most basic level, slowly working your way to more complicated decisions. For example, you can start with something as simple as a savings account or CD.
Then, as your child learns about compound interest and sees their money grow, you can begin teaching about the stock market or diversified assets, such as mutual funds or ETFs.
The key, in the beginning, is to start small and let your teen get their feet wet as they learn how to invest. Then, while your teen is still home, you can guide them with their investing decisions by either letting them take the ropes and providing your advice or doing it for them but letting them watch alongside you.
1. Learning the Basics
Teens should learn the basics of investing. Don’t make it too complicated for them to start, or they’ll get overwhelmed. Instead, use resources and help them understand the investments such as savings accounts, CDs, bonds, and stock market basics.
Help them understand the risk and reward, and even talk about mistakes you’ve made in your investing career so they can avoid making the same mistakes.
You decide how much to guide your teen in their investing decisions. Do you intervene and guide them another way, or let them take what you’ve taught and make their own decisions? Hands-on investing is the best way for teens to learn, but you know your teen and their investing style the best.
2. Figure Out Your Investor Profile
For teens to make investing decisions, they must determine their investor profile. This is something they should do themselves, with your guidance.
First, they should determine their risk tolerance. You probably already know if your teen is a risk taker, but let them discover for themselves. Those comfortable taking risks might invest more aggressively than those not ready to take risks. If you have a risk taker, enforce the idea of diversification so they don’t put their entire portfolio at risk.
Next, teens should decide how to allocate their portfolios based on their risk tolerance and values. For example, do they want income-based stocks that pay dividends that they can withdraw or reinvest or do they prefer value stocks with more stability?
Teens should also determine if they want to actively or passively manage their portfolios. Active management means you/they handle buying and selling stocks and other assets, and passive management means a robo-advisor, like Robinhood, does the work for them.
Most importantly, teens should diversify. This not only lowers the portfolio’s risk but also exposes teens to different investment types, helping them learn more.
3. Consider Your Investing Options
Teens have many investment options or types of accounts they can own. Knowing your teen’s investment goals and capabilities will help them choose the right investing option.
Uniform Gifts to Minors Act Accounts (UGMA)
UGMA accounts or Uniform Gifts to Minors Act is a custodial account that a parent or guardian owns until the teen turns 18. UGMAs can hold most assets, including stocks, bonds, ETFs, and mutual funds. Teens can use the funds however they want when they turn 18, including paying for college, buying a house, or any other use they choose.
Uniform Transfers to Minors Act Accounts (UTMA)
UTMAs or Uniform Transfers to Minors Act accounts are similar to UGMA accounts, but in addition to stocks, bonds, ETFs, and mutual funds, teens can have real estate investments in the account. Like UGMA accounts, teens take control and possession of the account when they turn 18.
Minor Roth IRA
A minor Roth IRA helps teens get a head start on retirement savings. Most teens don’t think about or understand retirement, but starting them young gives their earnings more time to compound.
Parents or teens can contribute up to $6,000 or the equivalent of the teen’s annual earnings, whichever is less. Teens must have earned income to open a Roth IRA, but it doesn’t have to be W-2 income; it can be money earned from babysitting, mowing lawns, or any other type of self-employment.
Roth IRA contributions are after-tax, so the money and contributions grow tax-free, and when teens withdraw the funds in retirement, the withdrawals are tax-free.
Minor Brokerage Account
Parents or guardians can open a minor brokerage account at many brokerages, including Acorns and Fidelity. Most minor brokerage accounts give teens access to their portfolio, but all trades must be with parental consent.
Once your teen chooses their account type, they must decide what type of assets to invest in, such as:
- CDs: Certificates of Deposits are time deposits made at a bank. Teens tie their funds up for a specified period, usually three months to 5 years. The longer the timeline, the higher the interest rates they’ll earn. Teens should choose timelines according to their goals, though, as early withdrawal can result in financial penalties.
- High-Yield Savings Accounts: HYSAs are online savings accounts that pay higher APYs than traditional banks. Some banks pay as much as 15x the average savings account interest rate. HYSAs don’t have a required time that the money must remain in the account, but teens can make only six withdrawals per cycle.
- Mutual Funds: A mutual fund is an investment company that pools funds from multiple investors to invest in various assets. They are actively managed, so there are higher fees, but teens can diversify their investments automatically with one fund. Mutual funds only trade once a day after the market closes.
- Exchange Traded Funds: ETFs are also an investment in an investment company that pools funds from multiple investors. ETFs, however, are passively managed, so there are fewer/lower fees, and they trade throughout the stock market’s trading hours.
- Stocks: You can invest in individual companies by purchasing stocks for teens. They can buy dividends or value stocks. They should always diversify their portfolio, though, either by investing in stocks in multiple industries or adding conservative investments, such as bonds, to their stock portfolio.
- Bonds: Teens looking for a more conservative investment can invest in bonds, especially government bonds. Most bonds pay a fixed interest rate and have a term of up to 30 years, but teens can cash them in sooner if necessary.
4. Open and Fund Your Account
Once teens choose their account type, they can open the account with a parent’s help. You can open most accounts online but must provide proper identification and information, such as the date of birth and Social Security numbers of everyone on the account.
After opening the account, parents or teens can fund the account. In addition, most online brokerages allow you to link an external account to fund it. This enables teens to set up automatic contributions, which ensures more regular investing rather than remembering to contribute each time they get paid.
5. Start Investing
With the account open and funded, it’s time to start investing. Depending on the type of account, teens and parents might need to actively manage the account. However, if you open a Robo-advisor account, the app does everything for them. All teens have to do is provide answers to the Robo-advisor’s questions to ensure they get the right portfolio.
Once teens start investing, the most important factor is determining how frequently they or you will contribute to the account. Parents can gift up to $16,000 per year in 2022 and $17,000 in 2023 without any tax implications.
Teens can also contribute funds they earn from their job or receive as gifts. Just be mindful of the IRA laws if you set up an IRA for your teen. The contribution limits are lower ($6,000 in 2022 and $6,500 in 2023.
How Parents Can Start Investing on Their Child’s Behalf
Parents can help teens invest or invest for them. The best way is to open a custodial or joint account and show your teen the ropes. Investing for them sets them up for the future, but it doesn’t help them learn.
Instead, guide your child and show them what you’re investing in and why. Then, let your teen help you choose the investments and watch the progress.
If you want to help monetarily, there are several ways parents can help:
- You can gift up to $15,000 in 2022 or $16,000 in 2023 tax-free. Consider matching your teen’s contributions, similar to what an employer would do with a 401K.
- Provide one-time gifts or deposits to get them started.
- Consider a 529 Savings Plan to help your child pay for college with tax-free funds.
What You Should Know About Kiddie Tax
Investors must always consider their tax liabilities when investing, even kids. The IRS has changed the so-called Kiddie Tax many times through the years, but the premise is always the same.
A small amount of a child’s unearned income, such as capital gains, is tax-free, but only the first $1,150. The next $1,150 is taxed at the teen’s tax rate, and anything beyond that is taxed at the parent’s marginal tax rate.
This means any earnings over $2,300 will likely be subject to much higher tax rates and could affect your teen’s earnings.
Example of How Investing for Teens Can Impact Their Future
Teen investors get a head start of 10 to 20 years on compound interest. In addition, enrolling in a Robo-advisor or investing app allows teens to make investments, sometimes as small as $5.
Even if a teen invests $5 a week for 50 years, starting at age 15, they’d have $233,824.63 if they received an annual rate of return of 9%.
Of course, as your teen ages and starts a career, they will increase their investments much more than $5 a week, but you can see how investing $5 weekly can turn into an impressive balance.