Talking to Kids About Investing
If you’re not teaching your child about investing, you should be – eventually. You’ll want to first make them aware of money and other financial concepts, but once they have the basics down, you’ll want to start familiarizing them with knowledge about the stock market and other investments.
With enough exposure and explanation, you can equip them with the financial literacy they need for adult life. This means understanding things like:
- How to think about companies as investments (stocks)
- How the stock market works
- What risk you take on by investing
- Where to get the funds to start investing
Table of Contents
Tips to Teach Investing to a Child
1. Include Kids in Financial Conversations
Before you make your child comfortable with the concept of investing money, you’ll first need to make them comfortable with the general concept of money. And that includes simply talking to them about everyday money subjects.
This doesn’t mean a formal discussion or a college lecturer’s prepared remarks. Casual dinner table conversations, observations at the grocery store or even discussion while waiting in line for ice cream are perfect ways to teach kids about money.
You still want to keep it simple, covering personal finance basics such as what it takes to earn money, how to create a budget or pay bills, or even how to determine which things to save up for.
When approaching most topics, you can almost always find some relevant way to relate a financial angle for your kids to understand.
For example, scheduling a family vacation rarely happens overnight and often takes deliberate planning ahead of time—that includes budgeting for the costs of the trip and making concerted actions today to save enough money to make the vacation a reality.
Just the same, a family might also choose to finance the entire trip with a credit card, which is effectively a loan.
Both ways get you the enjoyment of taking a vacation, but one carries a measured approach that finances the trip with money you’ll earn prior to taking the trip while the other borrows against future income earned after the trip—and potentially at a cost (interest).
For the planned approach, such steps you’d likely take include beginning to set aside money in your family’s budget over a period.
In doing so, you avoid needing to come up with funds all at once, and instead make the necessary funds available over time without sacrificing the needs you have today. However, by saving money ahead of time, you might also miss out on experiences you’d like to have prior to the trip.
If you borrow money by using a credit card, it avoids the sacrifice today, though potentially at the cost of paying more than the trip was worth tomorrow.
That interest expense also will reduce what you have left over to pay for future expenses, and might make it more difficult to enjoy experiences you want to have in the future.
In both cases, include your kids in thinking through the trade-offs of both scenarios.
Laying out this kind of decision-making can help your kids to connect the dots for how good things happen with deliberate effort and planning ahead. And as we’ll see in a moment, it can also help you when it’s time to teach them about the basics of the stock market.
2. Explain How Companies Work
Once you’ve covered these fundamental topics, you can move on to how a company works. That means discussing concepts such as revenues, expenses, profits and cash flows.
That probably sounds daunting, and it would be–if you tried to explain it to them using boring dictionary definitions. But you won’t. Instead, you’re going to make these terms relatable by explaining them via the lens of concepts they’re already familiar with.
For instance, if you’ve already had basic conversations about the household finances, they know you take home a paycheck. In a way, that’s your revenue–the money you bring in every month.
You’ve also likely told them about the bills–things like the mortgage or your rent, power, water, cable/internet and phone. Those are examples of expenses.
And in fact, companies have many of the same types of expenses! A business typically will own or rent a building, and it needs to make sure its workers have electricity, heat, internet connections, water and more.
Whatever is left over at the end of the month, after paying all the expenses, is effectively your profit. And just like with companies, you can tuck your profit away for a rainy day, or you can reinvest it–in the family’s case, you might invest it in your retirement plan, or in a business’s case, they might reinvest it in new facilities or equipment.
Cash flow can be a bit more difficult to explain. Show your child a budget that lists both expected income and expenditures throughout the month. It all makes sense on paper–but it might play out differently depending on when certain items hit.
For instance, let’s say you have to pay bills at the beginning of the month, but you don’t get paid until the middle of the month. That means if you don’t manage your cash properly at the end of one month, you won’t have enough in cash flows to pay for those expenses at the start of the next month.
You can explain other concepts this way, too. Consider our discussion about planning a vacation. The family that saves up to be able to afford a vacation is taking less risk, and isn’t adding on extra expenses to buy the things they want.
Similarly, companies that can fund investments from their own cash flow and cash reserves–instead of needing to seek outside financing–often make more attractive investments.
Remember: Kids learn best with examples. That means as you’re providing these examples using your personal finances, you don’t even need to necessarily share the actual numbers. You just want to make sure you’re illustrating financial concepts that they can understand.
And believe it or not, lessons like these can be an opportunity for yourself. For instance, as you explain your monthly obligations to your child, you might identify a negative money pattern that you’ve never noticed before. If you do, don’t hide it–fess up, then correct this behavior.
By doing so, you have helped your own budget, you’ve taught yourself something, and you’ve helped your child develop good money habits.
3. Talk About Stocks and Bonds (And Savings Accounts!)
Investing involves many components, but one of the simplest breakdowns – stocks versus bonds–is relatively easy to understand, and can also help demonstrate the concept of risk.
First, you’ll want to explain what a stock is, and what a bond is.
A stock represents ownership in a company. It might be a tiny fraction of ownership–a millionth, a billionth, possibly even smaller–but it’s nonetheless a way for you or I to own a piece of another business. Apple. Amazon. Facebook. You can literally own a piece of some thousands of companies you will interact with throughout your life.
When you own a stock, you are entitled to share in the success (and failures) of that company. It’s a little oversimplified, but you can explain that when the company does well, the value of the stock will increase.
When the company does less well, the stock price (and value of the stock) will decrease. And, of course, some companies will actually pay you just for holding on to that stock (called a “dividend”).
A bond is a little different. A bond isn’t a piece of ownership in a business. Instead, it’s more like a financial agreement. In exchange for buying a bond from a company now–which helps the business finance things it needs to survive and grow–the company will eventually pay you back (the “principal”), and also make regular payments to you along the way (“interest income”).
Bonds don’t go up and down nearly as much as stocks do, which in a way makes them less lucrative, but they generate income and are a safer way to invest your money.
You can then explain to your child that stocks (and to a lesser extent, bonds) act fundamentally differently and involve much different levels of risk and return compared to, say, a bank account or banking app your child may already have.
And over time, they will begin to understand the benefits and drawbacks of each.
4. Explain the Power of Compounding
Compounding provides investors a return on their returns. It adds lagniappe–a New Orleanian (French) way of saying something extra–to your investment portfolio.
However, despite many investors’ love affair with compounding returns, it might not be the easiest concept to explain to small children. Your best bet is illustrating the concept, which you can do via the doubling penny exercise. Start first by asking if your child thinks a penny represents a lot of money. Almost inevitably, they’ll say it doesn’t. Then, ask if a penny doubled every day for a month would turn into a lot of money. Have fun seeing them do that mental math in front of your eyes. Spoiler alert: Those numbers get big, and they get big fast. What starts as a humble penny at the beginning ends the month in style and largesse: over $10 million (for a 31-day month; over $5 million for a 30-day month).| Day | Dollars | Day | Dollars |
|---|---|---|---|
| 1 | $0.01 | 16 | $327.68 |
| 2 | $0.02 | 17 | $655.36 |
| 3 | $0.04 | 18 | $1,310,72 |
| 4 | $0.08 | 19 | $2,621,44 |
| 5 | $0.16 | 20 | $5,242.88 |
| 6 | $0.32 | 21 | $10,485.76 |
| 7 | $0.64 | 22 | $20,971.52 |
| 8 | $1.28 | 23 | $41,943.04 |
| 9 | $2.56 | 24 | $83,886.08 |
| 10 | $5.12 | 25 | $167,772.16 |
| 11 | $10.24 | 26 | $335,544.32 |
| 12 | $20.48 | 27 | $671,088.64 |
| 13 | $40.96 | 28 | $1,342,177.28 |
| 14 | $81.92 | 29 | $2,684,354.56 |
| 15 | $163.84 | 30 | $5,368,709.12 |
You also can show your child how compounding works through an actual bank account. You can use the Greenlight app to create a General Savings account and give them “Parent-Paid Interest.”
This gives you the opportunity to set and pay an interest rate of your choice from 1% to 100%. This will usually amount to a rate better than you can get on any traditional bank account while showing your kids how their money grows when they make responsible saving decisions. Each month, you can review the account with your child to show them how even their interest earns interest. Now, you can really connect the dots between compounding interest and compounding returns through investing. The money you earn through a bank account (or the “Bank of Mom & Dad” with Greenlight’s Parent-Paid Interest) carries no risk and earns little interest. However, your child could grow her money faster through investing in the stock market–if they’re willing to take on the additional risk. Make sure whatever goal your child chooses, the investment choice you make matches the timeline. If they have something near-term in mind, consider a Certificate of Deposit (CD) or a bond fund. If it’s something closer to five or 10 years down the road, a stock fund would be more appropriate–and help them reach their financial goal even faster.5. Teaching Your Kids the Stock Market Isn’t a Casino
Children also need to understand the difference between investing and gambling money at a casino.
This is another difficult concept to teach because in many ways, both involve luck–and both involve skill.
Gambling in a casino is a pretty short-term bet that, depending on the game, is somewhat, mostly or entirely based on luck. Slot machines, for instance, are completely based on luck, as are roulette wheels.
However, blackjack and poker involve some amount of skill–understanding odds, reading other players’ emotions. But over time, “the house always wins.” If your average player keeps gambling long enough, they’re going to rack up losses.
Not so with the stock market, where even the most inexperienced investor can still listen to a little basic advice, buy a couple index funds, and average a 7%-8% gain over time. Yes, luck is still involved–no investor can know every last detail about a company they buy stock in–but the game isn’t as rigged against the little guy as it is in a casino.
Still, some people can treat the stock market like a casino. Your best bet is setting the right example for your children. A few tips:
- Keep trading to a minimum.
- Buy most stocks with at least the intent to hold them for at least the next five years, if not much longer.
- Diversify your portfolio via funds holding many bonds, stocks or other assets.
- You can source your stock ideas through a stock picking service, investment newsletter or stock advisory service or even by following the news for major company developments. (Just remember: Don’t impulsively respond to and trade on every little nugget of market news.)
6. Consider a Stock Market Game
A great step for younger children who want to start investing is to have them use play money and track stocks and their portfolio management results. Specifically, online stock market games can allow parents and children to discuss the rules and finer points of investing in an effort to build their financial literacy.
One online tool you might consider comes from the SIFMA Foundation, which offers the Stock Market Game. Their app works for children in grades 4-12.
The Stock Market Game introduces young people to saving and investing through a simulated stock market and bond market. Students receive a $100,000 virtual investment portfolio they get to trade and manage on their own.
You can also have your child read a couple of investment books for kids, and they can put that theoretical knowledge to practical use by improving their ability to pick investments in the game.
Ultimately, however, nothing will get your child more interested in the stock market than having real money in the real world at stake.
7. Open a Real Investing Account
Eventually, the goal should be to open a real investing account for your child.
You have several options if you need an investing account for a minor. Depending on your investing goals and desired use of the funds down the road, you’ll want to consider different options:
529 plans (Education)
If you’re looking to invest toward educational expenses, you might look into opening a 529 plan through a company like Backer. These accounts allow you to make after-tax contributions toward an investment account that doesn’t require you to pay taxes on gains as long as the funds pay for qualified educational expenses.IRAs (Retirement)
It’s not sexy, but starting kids on the path to retirement super-early will work in their favor. Those compounding returns will really kick in toward the end of their careers, when contributions don’t do as much as ongoing gains. If your child has earned income, strongly consider investing in a Roth IRA for kids, easily one of the best investments for kids.Custodial accounts (General purpose)
Custodial accounts are one of the most common ways to invest for minors. These accounts carry the name “custodial” because the funds will be controlled by a parent or guardian until your child reaches adulthood, at which point they can do whatever they want with those assets. Related:- Best Investments for Teenagers
- How to Start Investing as a Minor
- Best Bar Mitzvah Gift Ideas [Financial Gift Ideas That Last]
8. Let Your Kids Invest
Once your kids understand the basics of investing, it’s time to let them invest!
Among the tasks that should be helpful to your child throughout their investment journey:
