Teaching Kids Investing Basics

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Ask Carrie: Carrie Schwab Pomerantz - The Personal Side of Money

Teaching Kids Investing Basics
by Carrie Schwab-Pomerantz, CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
April 23, 2008

Dear Carrie,

My son is 12 and I want to get him acquainted with investing in stocks, bonds, funds, etc. What is the best way to get him started?

—A Reader

Dear Reader,

As a firm believer in starting a kid’s financial education early, let me congratulate you on taking an interest now in teaching your son about investing. You have an exciting opportunity to put him on a firm financial path—to share the journey with him—and to watch him grow in knowledge and skill.

At 12, your son should be able to grasp many of the basic concepts and relate them to his own life. The more tangible and real you can make investing, the more interested your son will be.

But before you talk to him about investing, make sure he has a firm grasp of the importance of saving. Has he regularly been setting aside about 10% of his earnings from allowance, gifts or small jobs? Have you opened a savings account for him and discussed how interest works? While these things may seem basic, they are important first steps in learning to manage money. Once your son has a savings plan, you can more easily move on to investing.

Here are some practical approaches that I’ve found effective for kids of all ages:

Keep it simple—While there’s a lot to learn, when it comes to kids, I always suggest keeping investing simple. Use your son’s language. Start by explaining that investing is a means of using your money to create more money.

Use a real goal—Make investing real by focusing on a tangible goal. Chances are your son already has something he’s working and saving for. What’s on the top of his list? A new computer game? Saving for a car? By showing him how investing money on a regular basis can help him earn more money to achieve his goals, you’re more likely to catch—and keep—his interest.

Explain stocks with familiar companies—Kids seem particularly taken by the idea that buying a stock means buying a little piece of a company whose value can rise or fall as the company succeeds or fails. If you tie the concept to a company that your son may be familiar with, say a sports, computer or food and beverage company, he might be interested in following the company’s progress. Better yet, you might consider buying him a single share, so he can experience ownership first hand.

Try virtual investing—Show your son how to research stocks online. Once again, pick companies whose products he knows or uses. Have him “buy” 10 shares of a few companies he likes. Record the “purchase price,” monitor the performance and, after a month, have him calculate what he gained or lost. There are also several online virtual trading sites where your son could get some hands-on “trading” experience without investing a dime!

Open a custodial account—To give your son some real investing experience, consider setting up a custodial account under the provisions of the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act (depending on your state). It’s easy to do online or your Schwab consultant can help. You can start the account with a small amount of money and have your son contribute a portion of his savings to the account as well. You might even offer to match his contributions. Your son can help you select appropriate investments. Then together you can have quarterly check-ins to review how well the investments have performed.

As you and your son explore investing together, don’t forget to emphasize the following essential concepts whenever possible. To me they form the foundation of smart investing—for kids and adults alike:

Long-term investing—Any market has natural ups and downs but the longer you have to invest, the greater chance you have to ride out these market movements. Historically, over time, investing, particularly in stocks, has been an effective way to help your money grow and keep it from being eroded by inflation. (Note that this lesson is very different from what many kids are learning from the various stock market games offered in schools.)
Compound growth—Time is probably a child’s greatest asset. That’s because of the power of compound growth. Here’s a way to explain it: As earnings are reinvested back into your original investment and the aggregate amount keeps earning, it’s kind of like a snowball that gets bigger as it rolls down hill. The earlier you start investing, the greater the snowball effect. It’s an image kids can readily understand.
Risk and reward—When it comes to investing, these two things go hand in hand. There certainly are plenty of recent examples to help underscore this point! The key is to understand how much risk you’re willing to take to earn a potential reward. For example, stocks, bonds and mutual funds are generally more risky than a savings account, but they can also provide the potential for a higher return. This brings us back to the idea of taking a long-term view. Money you need in the next three to five years probably shouldn’t be in the stock market. The risk is that you might have to sell when the market is down. But with your long-term goals, you have more time to ride out market volatility for the potential of a greater reward.
Diversification—It’s risky to put all your eggs in one basket. For instance, it’s probably not a good idea to invest all your money in the hottest video game or clothing company. If the company falls on hard times (or a host of other possibilities occur), you could lose your money. A great way to minimize risk is to spread your money across different types of investments. For instance, when you invest in a mutual fund, you own a little bit of a lot of companies, so your assets aren’t tied to the success for failure of any one company. So given this, if your child has enough money, think about investing at least half in a well-diversified mutual fund, reserving a small balance for individual stock exploration.

SchwabMoneyWise.com is a great resource for ideas on how to teach kids about money and investing, with worksheets and activities you can do together. It also has some basics on asset classes and investing strategies that you may find helpful in introducing these concepts to your son.

With the current market volatility and all the economic news broadcast everyday, this may be a perfect time to get your son interested in investing—as well as teach him some real-life lessons in risk. He’ll see that investing isn’t just an idea or a game, but a very important part of the real world that’s always changing and never dull!

Good luck!

Important Disclosures

Investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost. Past performance is no guarantee of future results.

Diversification strategies do not assure a profit and do not protect against losses in declining markets.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction and investment strategy for his or her own particular situation. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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