So, you're child is a regular Rockefeller.
They're ready to move their money into the stock and bond markets but don't know how or if they even can.
Why is that? Well, maybe they're still in school, only 16 years old.
Or maybe you're a parent and your child has come to you and wants to start trading stocks because they have developed a real interest in the markets.
In this post we'll look at what kinds of accounts you can open, explain the differences, who has control, what brokers to look at and the reasons why it is good for a young person to start investing early.
WHY SHOULD A YOUNG PERSON BEGIN INVESTING?
I remember having a class in middle school where we learned to watch stocks; back then it was in the newspaper. I picked my companies and used "play" money to buy them. Then, each day I looked up how the stock prices moved the day before.
I was hooked.
Not everyone is drawn to investing and for them it is better to leave it to the professionals. The bulk of my money is managed in low cost mutual funds and ETFs, but I still have some money I invest myself. I don't ever see me not doing that. I still love it, even though I'm not great at it.
What They Will Learn
1. They learn the mechanics of investing, how to buy and sell stocks, what is the bid/ask price, how to watch the prices on a chart...
2. They learn to watch how the markets react each day as they move up and down.
3. They learn to keep abreast of current events both nationally and internationally and the effects the news has on the markets.
WHAT KIND OF ACCOUNT TO OPEN?
If they're under age 18, they will need an adult to open an account for them. This is called a custodial account and there are two types:
1. UGMA (Uniform Gifts to Minors Act)
2. UTMA (Uniform Transfer to Minors Act)
The main difference is the UTMA account gives the adult more time to control the account, while the UGMA account can be controlled by the minor when they reach the age of majority (varies by state).
What is a custodial account and what are the differences?
A custodial account protects the assets of a minor until they become an adult. It is opened by an adult for a minor and controlled by the adult until the child turns the age of majority, which is 18 to 21 years of age, depending on the state.
The taxes, if any, are taxed at the kid's rate (kiddie tax) instead of the adult's rate. However, the total amount in the account is factored in when a child applies for financial aid. It's usually assumed that 20% of this money will be available to spend on college. So, there are pros and cons.
Brokerage or Roth IRA Account?
Next, determine if you want to open a brokerage account or an IRA.
You can only open an IRA as a minor if you have earned income. The contributions can only be up to the amount of the earned income or $5500, whichever is less.
So, if they don't have earned income their only choice is the traditional brokerage account.
Here's where we insert the "speak with your financial adviser or tax professional" phrase.
WHERE TO SETUP YOUR ACCOUNT
OK, so now you know what type of account they need, but where do you go to open it?
Most financial advisers currently recommend using a broker that has low costs and investing in mutual funds or ETFs that have low expenses.
Three companies that come up frequently are:
1. Vanguard (LINK)
2. Schwab (LINK)
3. Fidelity (LINK)
Each of these companies can help you open either a Roth IRA or a traditional brokerage custodial account.
Each offers low-cost funds and ETFs, as well as trading individual company stocks. Have them consider looking at index funds that allow them to invest in many companies for a small amount of money. Another option to consider is a target fund where they invest their money in a fund that has a mix of stocks and bonds based on how many years they have until retirement. For example, if they plan to retire at age 65 and that won't be for another 50 years, look for a target fund in 2066.
Of course, if they are like I was they will want to invest in individual company stocks. However, if they don't have much money they won't be able to buy many shares.
Usually IRA accounts require smaller amounts to open an account. Some of the Vanguard funds have larger minimums to invest.
All of these companies offer a wealth of education on their sites to help you or your child learn the markets, companies, and trading.
BEFORE THEIR FIRST TRADE
After their account is open, have them take a few moments before they make their first trade and think about the following:
1. What are your short-term and long-term goals? This will help determine your risk tolerance (see point two). If you don't need the money for many years you can probably stand to take more risk. If you want to buy a car next year, you probably need to be more conservative.
2. What is your risk tolerance? If it's low, consider money market, CDs, government treasuries. You won't make much but you shouldn't lose much either. If your risk level is high, your options are much larger and include stocks, and lower rated bonds.
3. Will you diversify? Do you want to put all your money in Disney cause you loved the new Star Wars movie? That is great if the stock does well, but not so great if it doesn't. However, if you buy stock in two companies or half your money in stock and half in a money market fund, your risk is likely less as one option could do poor while the other does really well.
I envy them.
If they're like I was when I was young, they can't wait to get started. Investing can be a lot of fun and it's something you can do the rest of your life.
If it's your child who wants to start investing, take some notes from this post and sit down with them to discuss. Share the joy with them. Who knows, maybe they will be the next Warren Buffett and can take care of you one day.
Thanks for reading!
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