Investing may sound complicated, but getting started is easier than you’d think (yes, even for teens). In this article, parents and teenagers will learn the benefit of investing for teens, the best investments for this age group, and what accounts you can use to start investing.
Why You Should Help Your Teen Start Investing Early
Individuals who start investing as teens rather than waiting until later in life have an advantage over their peers, both in their potential returns and the knowledge they can gain from investing. “Age is arguably a younger investor’s most valuable asset. This is because of compound interest, or the ability of your money to start earning its own money,” Taylor Jessee, a CPA and CFP and the director of financial planning for financial consulting firm Taylor Hoffman, shared. “The earlier you start investing, the longer you’ll have your money being put to work for you.” Let’s take a look at an example. Imagine a 15-year-old who starts investing $150 per month into a brokerage account with a 10% annual return. If they were to invest just $150 per month until age 60, with compound interest, they would have more than $1.3 million saved. On the other hand, someone who started investing the same amount at age 35 would have less than $180,000 by age 60. Investing as a teen helps young adults prepare financially for the future. It also helps teach them financial literacy. For many, personal finances are a source of stress and anxiety. A 2018 National Financial Capability Study from the Financial Industry Regulatory Authority (FINRA) found that 53% of Americans consider their finances to be a source of anxiety, with respondents ages 18 through 34 reporting the highest levels of stress. By helping your teen build their financial literacy from a young age, you may help them feel more confident and less anxious about money matters later on.
What Teens Should Invest In
With so many investments to choose from, all of which have varying levels of risk, it can be difficult to know where to start investing. Below are some of the most common investments available to teens as well as some of the downsides you should be aware of.
High-Yield Savings Accounts
A high-yield savings account (HYSA) is the most basic way for a teen to start earning a return on their money. Savings accounts have been around for a long time, but more financial institutions now offer high-yield savings accounts, which offer a higher interest rate than a standard account. With a higher interest rate, your funds will grow more than they would in a typical savings account. However, even savings accounts with high yields have very low rates of return compared to other investments.
Certificates of Deposit
A certificate of deposit (CD) is a banking product similar to a savings account through which a teen can earn interest from their savings. The key difference is that CDs require you to keep your money in the account for a specific period of months (or even years) to earn the promised interest rate. Then, when you redeem the CD at maturity, you’ll get your money back in addition to the interest your account earned. Like savings accounts, CDs are considered a risk-free investment because the money is insured by the FDIC for up to $250,000. The downside, however, is that your money is essentially locked up for a period of time.
Stocks
A stock is a way to take a piece of ownership—also known as “equity”—in a publicly traded corporation. When you own a stock, you become a shareholder and part-owner of the company. Investors can earn money from dividends that companies pay to their shareholders as well as through capital gains when the value of the stock increases. “You could take a small piece of your portfolio and pick one or two stocks as a way to learn how to follow and evaluate individual stocks,” Jessee said. “Consider picking one or two companies you’re familiar with, so it’s easier to follow and relate to.” Before adding stocks to your teen’s portfolio, you can work together to open a virtual trading account—also known as “paper trading”—where you can practice buying and selling stocks without real funds. Virtual trading can give your teen an idea of how the stock market works without putting any money at risk.
Bonds
A bond is a type of debt security. When you purchase a bond, you’re essentially lending money to the issuing company or government entity. While bonds might not necessarily be as exciting to a teen as stocks, they’re generally more stable investments, meaning they help create a well-diversified portfolio. Bonds usually provide a fixed income from the interest payments the bond issuer makes throughout a set period of time.
Funds
Funds, primarily mutual funds and exchange-traded funds (ETFs), are popular investments that allow you to gain exposure to many different securities in one investment. Mutual funds and ETFs are known as “pooled investments” because they pool together the money of many investors.
Mutual Funds: A mutual fund is technically a type of investment company that pools the money from many investors to create a well-diversified portfolio. Each investor is part owner of the fund, with a share in its profits and losses. All mutual fund orders are settled at the end of the trading day, regardless of when they were placed. Exchange-Traded Funds (ETFs): An ETF is another type of pooled investment that allows investors to add many securities to their portfolio through a single investment. One key difference between ETFs and mutual funds is that ETFs trade throughout the day like stocks. Like a stock, you can buy one share of an ETF and have more control over the price. “I usually recommend starting with an index ETF or mutual fund, so you get immediate access to a diversified portfolio instead of putting all your eggs in one basket with just one stock,” Jessee said. “This makes even more sense if you’re starting out with a small dollar amount to invest.”
Opening an Investment Account for Teens
If your child is under 18 years old, the most effective way to start investing for or with them is to open a custodial account. With this type of account, an adult “custodian” opens an account and can save and invest money on behalf of the child. Then, when the child reaches adulthood—either 18 or 21, depending on the state—they’ll take full control of the account. “Keep in mind, assets in a custodial account legally belong to the child—the account beneficiary,” Jessee said. “The parent or custodian is merely a placeholder until the child reaches legal adulthood. This means that if a parent puts money in a custodial account for a child, it is considered an irrevocable gift and cannot be taken back. In other words, that money now belongs to your child.” There are two common types of custodial accounts: Uniform Gifts to Minors Act (UGMA) accounts and Uniform Transfers to Minors Act (UTMA) accounts. The two are almost identical but vary in the types of assets they can hold. UGMA accounts can hold financial assets like stocks, bonds, mutual funds, and cash. UTMA accounts can hold all of those same assets as well as physical assets like real estate.
The Bottom Line
Most people understand that they should be investing, but many may not have considered the benefit of investing for or with their teens. Getting teens started with investing at a young age can help them build wealth and financially prepare for the future as well as provide them with the financial literacy they will need to succeed later in life. Under the kiddie tax, the first $1,150 of a child’s unearned income is exempt from federal taxes for 2022. The next $1,150 is taxed at the child’s tax rate, which, assuming the child has little to no income, will likely be the lowest tax bracket. Finally, any earnings above $2,300 are taxed at the parents’ tax rate.
