Once your children understand the concept that their money can make money for them when they lend it out to someone, you can talk to them about different ways to invest. First, you have to explain the concept of risk: if you lend out your money, you are taking the chance that you will not get it back. With a bank account, this risk is very low. However, other options regarding investing for kids carry greater risk. So why would you want to make risky investments? The answer is simple: because high risk means that you might have a higher reward paid back to you.
The second big idea to teach them if they want to lend out their money is diversification – they should never put it all in one place. Remember, lending (or investing, depending on the term you prefer to use) means you might not see your money again. So if you lend all of it, you might lose all of it. If you lend just a little and lose that chunk, it hurts less. Building on the farming or seed metaphor I used to explain interest, think about an apple tree. A farmer plants an apple tree but needs to nurture it for many years before it bears fruit, or in financial terms, becomes a long-term asset provider. The apple tree needs to be protected against bugs, drought, storms, and angry people with axes, so if you think about it, one apple tree really isn’t enough. Every good orchard was planted a long time ago by forward-thinking folks. The same line of thinking explains why we have diversified investment portfolios that we create for future use.
An easy way to start talking about investing is to make investments on behalf of your child. Instead of giving them $100 in cash for their birthday, think about opening an account for them. This could be a custodial IRA or a 529 designed to put money away for college. Explaining the tax benefits of these accounts is probably beyond what a ten-year-old cares about. But the idea that we put money away for a future purpose in a way that earns us a little more money is a great concept to know. Let her watch the money in the account grow. An extra benefit of gifting money this way instead of giving her cash directly is that you do not need to worry about how the money will be spent—at least for now.
If you’re interested in other ways to introduce your children to investing, you can talk to them about the stock market. I grew up in a house where investing was often discussed. My dad was, and still is, a Chartered Financial Analyst—he manages wealth for his clients. Much of that involves buying and selling stocks, and our dinnertime conversations often touched on the ups and downs of his job. But much of the discussion was without a ton of emotion; it was simple and factual. Learning the basics of investing was an incredible gift—one I intend to pass along to my children.
In my reading I came across multiple examples of people who thought it important for their children to have some exposure to investing in the market and found creative ways to get their children excited. Again, these are complex concepts, but the idea of having equity in a company is a good place to start. You can use the example of something like a lemonade stand. If your child wanted to open a lemonade stand, he would need to buy things like lemons to get his business started. Maybe he has enough money in one of his piggy banks to buy five lemons. But if a friend lent him $5, he could buy more lemons at better prices and then sell more lemonade. You can explain to your son that he would either have to pay the $5 back to his friend (with interest) or he could make his friend a co-owner of the lemonade stand. If he chooses the latter option, he does not have to pay the $5 back, but he does have to share any profits the lemonade stand makes.
To explain buying stock, just substitute in a real company for their lemonade stand. Choose a company they care about. Maybe your child loves Disney movies or John Deere tractors. Wouldn’t it be exciting if he could own the companies that make those things? Clearly, he cannot own all of the company—but he can own some of it. To buy little pieces of the company, he buys the company’s stock. And there you have it: investing in the stock market. The best way for children to learn this lesson is through picking and choosing stocks themselves, and watching their values change over time. If you want to prepare children on the premise of investing in what they know, you can look at historical charts of companies that worked around fads and show them how stock prices change based on the success or failure of fads.
In my reading, experts had different strategies for giving children practical exposure to investing in stocks. Money Still Doesn’t Grow on Trees by Neale Godfrey suggests first having your child choose a few stocks she cares about and then tracking changes in value. Once she is old enough, Godfrey recommends opening an account for her with your broker but letting her make decisions about where the money goes. If you want to practice picking stocks without getting a broker involved, First National Bank of Dad by David Owen has a neat solution. He gave his children a certain amount of money to invest. The children chose stocks and “invested” an amount that was tracked on a spreadsheet Owen created against the real-life value of the stocks. If the children wanted to liquidate, they could take the present value of the money (any delta was absorbed by Owen). Alternatively, they could change strategies and invest in different stocks.
Children’s Investing Guides
Katherine Bateman, The Young Investor
Gail Karlitz, Growing Money
Tamra Orr, A Kid’s Guide to Stock Market Investing
Rick Roman, I’m A $hareholder Kit
Whatever approach you choose, the idea is to give your child some exposure to investing and to teach them your philosophy about investing. Among the hard copy material, blog websites Education and Investopedia provide great first steps in the teaching process. If you dislike investing in the stock market, make sure you tell them why. Again, ignoring a reality doesn’t mean it does not exist. If you have an investment strategy that you think is smart, explain it—but build the proper foundation so your child will want to emulate your financial behaviors.