Time is money. When it comes to investing, this adage is even more critical. The average American worker starts investing for retirement at age 27, and your child can do much better than that.
The earlier you can get your child to start investing, the better. If you were to invest $1,000 for your child in stocks on their birthday and let it grow, that one-time investment could grow to $490,370 by your child’s retirement. In this example, we’re using the 10% average long-term return of the U.S. stock market.
Keep in mind that the actual final value may vary for many reasons, such as market fluctuations, time horizons, taxes, and fees.
In this Q&A guide, I will answer some common questions about how to get your child on the right track with early investing. You have to have a plan, as good investing habits don’t happen overnight. I’m here to help you build an investing strategy for your child.
I’m Jordan Wexler, CEO and co-founder of EarlyBird, an investing platform that helps adults set up custodial investment accounts for their children. Let’s explore the right approach to delivering valuable financial lessons and preparing your child to invest independently.
At What Age Should I Start Teaching My Child About Investing?
Investing habits and money habits start early. So, you need to be conscious about building them as early as possible.
Teaching your child about money is the first step, and teaching them about savings and investing is the second step.
In working with several parents through EarlyBird, I have seen firsthand that most parents introduce the concept of money to their children when they start giving them an allowance. Typically, an allowance starts around age 5 or 6.
An allowance is a great learning opportunity because it allows your child to choose between using that cash immediately or letting it grow into something bigger. Many parents who use EarlyBird will have a $20 bill in one hand and the EarlyBird app in the other and will ask their children, “Do you want the $20 bill now, or do you want to put it into EarlyBird for saving?”
The child will choose the cash sometimes and the EarlyBird app at other times. And that’s how they start their journey to financial literacy.
Can Children Invest on Their Own?
No, most brokerages only open investment accounts for people aged 18 or over. So, your child won’t be able to make investments on their own until they reach that age.
How Can I Invest for My Child?
To invest for your child, you’ll have to open an investment account (e.g., a custodial Roth IRA, a 529 plan, or a UTMA/UGMA custodial account) with the child as the beneficiary and you as the custodian. You’ll have control over this account until the child reaches age 18 or 21, depending on your state.
Here are some investment accounts that allow you to make investments for your child:
- A UGMA custodial account, the most common type of custodial account, allows you to invest money in stocks, bonds, mutual funds, and annuities.
- A UTMA custodial account is another type of custodial account that allows you to make the same investments as those in a UGMA custodial account, as well as investments in alternative assets (e.g., real estate, jewelry, or collectibles).
- A 529 plan is an investment account used for eligible education expenses.
- A custodial ROTH IRA is a custodial account that allows minors who earn an income to save for retirement. This investment vehicle also allows you to buy stocks for a child.
You can get your child involved very early in selecting investments for these accounts. By making the act of investing relatable and exciting, you’ll make investing through EarlyBird or other investment accounts a fun habit over time.
How Much Can I Contribute to My Child’s Investment Account?
Here are the annual contribution limits for some common types of investment accounts in 2022:
- UGMA/UTMA custodial account: These types of custodial accounts don’t have a contribution limit. But contributing more than $16,000 for a single filer or $32,000 for a married joint filer will require you to fill out some additional IRS forms to avoid the estate gift tax.
- 529 plan: You can contribute as much as you want to a 529 plan. The same rule above applies here to avoid the estate gift tax.
- Custodial ROTH IRA: $6,000
Should I Let My Child Select Individual Stocks?
The majority of your child’s portfolio (80%) should go to a broad, well-diversified, ETF-based portfolio. Having a recurring and consistent contribution to a well-diversified ETF will pay off in the long run and provide your child a solid investment foundation that they can count on.
Thinking in terms of $100, you would allocate $80 out of $100 to a low-cost ETF that tracks the S&P 500 or another similar broad market index.
With the remaining $20 out of those $100, then you have an opportunity for individual investments that your child believes in. Feeling empowered to make an investment decision and acting on it are powerful ways to instill financial confidence in your child.
Here’s a gameplan on how to start a conversation on selecting individual stocks for that 20% of your child’s portfolio. After introducing an allowance at age 5 or 6, you can start talking with your child about other concepts, such as making consistent contributions to investment accounts (dollar-cost averaging) and choosing investments.
After some years, you can ask your child, “What are you interested in investing in?”
If they answer, “Playing video games, like Call of Duty,” you can build on that and ask, “Do you know who makes Call of Duty?” If they don’t know, you can research and find the answer together.
Or, if the child says “Activision,” then you can let them know that Activision is a publicly-traded company; therefore, they could own part of that company. Then, you can pull out your EarlyBird app or other investment app and make that investment a reality in front of your child.
Learning by doing is an effective way to build investing habits in your children.
What Are Good Stocks for My Child’s Investment Portfolio?
If you need some help with ideas for stocks for children, we put together a list of the best stocks for children to buy in 2022.
This list covers a set of criteria that you can use to teach your child about long-term investing and selecting stocks and exchange-traded funds (ETFs).
Keep in mind that actual investment performance can vary due to market fluctuations, time horizons, taxes, and fees.
What Is an Appropriate Investment Strategy for My Child’s Portfolio?
You want to have a diversified portfolio.
A core part of your portfolio is a mix of solid stocks and ETFs. And a diversified portfolio allows you to pursue other strategies.
The best overall investment strategy is to have a solid portfolio foundation that you can rely on for growth, and then having a portion that allows you to bring your child along in the investment journey and keep him or her engaged and active in the process.
What Are Some Examples of an Investment Mix for Children?
Let’s say that you have a portfolio of $100. The first $80 goes into the core portfolio you have set with your child, and your child knows this portfolio exists. The remaining $20 is for making investments that you and your child believe in.
In that core portion of your children’s portfolio, you should consider including a broad-market, low-cost ETF that tracks a large basket of domestic securities.
A great example is the Vanguard Total Stock Market ETF (VTI), which holds a wide range of U.S. stocks to track the U.S. stock market.
How Do I Explain Difficult Financial Concepts, Like the Power of Compounding, to My Child?
Financial literacy is best learned by doing and getting involved. There is a lot of great material out there. One example is our partner Benjamin Talks, which provides weekly content and has a blog. You can sit down with your child, read about financial topics, and start a conversation.
The key to passing down financial literacy and breaking down challenging financial concepts is a mix of having conversations, storytelling, and making it fun.
Compounding interest is best learned through the experience of seeing money grow in the stock market. Ensure that your child is involved in tracking the market and seeing how money in it grows over time.
How Do I Prepare My Child to Take Over Their Investment Account at Age 18 or 21?
You can prepare them by involving them deeply in the process from day one — think as early as 5, 6, or 7 years old. The main goal is that they’re not hit at age 18 or 21 with this huge lump sum of $10,000 or $20,000.
For example, if you set up a custodial account for your child, set up a recurring time (e.g., every 4, 6, or 12 months) to go over it with them.
Ensuring that your child is deeply engaged in the process makes taking over their investment account just a transition — a celebration. Taking ownership of these funds is not at all a surprise to them. They have been working at it for several years. With their new ownership of these funds, the hope is that they will continue to grow their wealth.
Still, be ready for your child to take some of that money and use it immediately. Maybe they’ll use part of the funds to buy a home, take a trip, or start a business.
That’s what money is for — having opportunities and building financial freedom.
It’s never too early to start investing for the children in your life. And teaching your children about investing will prepare them for when they reach age 18 or 21 and have to make investment decisions on their own.
If you’re interested in building diversified investment portfolios for your child, consider opening a custodial account with EarlyBird. We make it simple to open custodial investment accounts on behalf of your child and then invest in prebuilt portfolios of stocks, bonds, and other asset classes.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.