Overview

Education and Investing are the best ways for young people to develop their future. Their success is measured in terms of personal security for a lifetime rather than in millions of dollars. Investing starts with learning how to save for future wants and needs despite many distractions. Family teamwork is an invaluable aid. This Overview is aimed at helping families build a tradition of raising young investors.

Teamwork

Journalists and educators agree that children learn about spending, saving, and sharing money very early in life. Whether their money habits become useful or futile depends on the examples and coaching of trusted adults. Financial education starts at home where family traditions of money management set the standard. If there is no family tradition, then start one. Young investors need a team of parents and trusted adults to provide,

  • guidance
  • inspiration
  • experience
  • funding

Money Management

Money management is essential to investing and protecting financial assets such as stocks, bonds, and savings. Building good habits can be a family tradition or a new family experience. Either way, children start forming money habits early, before entering school. Many families teach the wise management of money by encouraging their pre-schoolers to store money in jars (chart 1). Any container would work -envelops, cartons, bowls, socks, etc.- but transparent jars are the favorites.

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chart 1, money jars
  • Spending Jar teaches decision-making and accountability. Children love money and never have enough to pay for everything they want. They should learn to spend wisely, track their expenses and accept the consequences of their choices. Learning to spend wisely can help them avoid future financial insecurity due to fluctuating income and overwhelming debt.
  • Saving Jar teaches investing. Saving leads to investing and the funding of financial goals. Start by helping children save for short term goals, then encourage them to gradually save larger amounts over longer time periods. Introduce them to the stock market by explaining that their favorite businesses sell shares of ownership. Consider helping them buy stock in their favorite company.
  • Sharing Jar helps build relationships. Expose children to the needs of their community. Community engagement will cultivate relationships and humane values.
Resources:

Dreams

Dreams are gateways to an exciting and prosperous life. Teamwork can help turn those dreams into financial plans for earning and protecting money. The earlier your child’s team begins the process, the better the chance of success.

Dreams can become realistic financial goals. Younger children dream of becoming grown-ups. For example, they wonder what adults do for a living and how parents earn incomes. Older children are inspired by classmates, role models, field trips, activities, etc.

childhood dreams
chart 2, dreams

Chart 2 shows examples of goal-starters:

  • teenagers want expensive things like cars and computers; they should save for it!
  • young adults think about weddings and buying a home; they should invest in it!
  • children dream of becoming millionaires; they could invest in a retirement account!

– My granddaughter read a story in The American Girl magazine about saving to become a millionaire. She was ‘hooked’. I discussed the article with her and asked her mother (my daughter) if I could provide some seed money to open an investment account. A year or so later, my granddaughter started earning money as a tutor and used her earnings to open a Roth IRA. She enjoys reading her financial statements and watching her investments grow in value. –

Starting a Roth IRA:  www.irakids.com

Earned Income

Chart 3 outlines the sources of income for children.

childhood income
chart 3, income
  • Unpaid chores are work assignments needed to run an efficient household.
  • Allowance is a regular gift of money that ‘allows’ young children to practice spending, saving, sharing, and budgeting money.
  • Jobs are types of labor performed by older children to earn money without a work permit. Not only do jobs enhance wealth but they also improve social skills and help children make decisions about future vocations.
  • Those who chose to turn a job into their own business are called Entrepreneurs. A successful business matches the skills of the child with the type of job; it also requires planning, organization, perserverence, and reinvestment.
  • Employment for wages in a regulated business requires children to have a work permit issued by the State.
Job suggestions:
50 small business ideas: https://smallbiztrends.com/2016/11/business-ideas-for-kids.html

Saving

Investments are a good way to save money for future use. Children have a BIG OPPORTUNITY to create wealth by reinvesting stock returns that will multiply the value of their investment. Chart 4 shows the future value of $1 invested in the stock market when all dividends and capital gains are reinvested in stocks. This mechanism of growth is called “compound interest”.

Compounding Interest
chart 4, growth of compounded stock returns

Dividends and capital gains are types of interest called “stock returns”.  The colored dots in chart 4 represent values of compounded returns at selected time intervals. One application of a growth curve is the use of time intervals to help plan big projects.  For example, childhood goals of saving for college and retirement fit into uniquely different time intervals:

  • The growth of $1 to $3 in 18 years is a realistic expectation of saving for college.
  • The growth of $1 to $30-$114 in 50-70 years is a nice investment for retirement.
More information:

‘Minor’ Requirements (‘red tape’)

Young investors need trustworthy adults to help navigate the red tape of opening a banking or investment account (chart 5). Minors (those youth under the age of 18 or 21 years depending on the state where they live) are unable to open the account without the written consent of an adult parent, guardian, or acceptable attorney. Full control of the account reverts to the young person at the age of majority (age 81 or 21 depending on the state).

family teamwork
chart 5, requirements

Big Projects

Big projects require saving thousands of dollars.

  • Short term projects include saving for a computer, car, vacation, or wedding.
  • Long term projects include saving for college, a house, or retirement.

Planning a big project requires setting the goal, estimating the deposits of money, overriding the obstacles, and occasionally reviewing the plan. A simple Retirement plan might be the following:

  • goal, save a million dollars [this may change later]
  • deposit 10% of earned income [this will change later]
  • override obstacles with frugal investing (chart 6) and other protections (chart 8)
  • review the plan when there are substantial changes of income, expenses, or personal life.

Frugal Investing

Brokerage firms charge fees for professional advice, trading services, accountants, and safekeeping of securities. The fees are inescapable, but they can be minimized by frugal investing (chart 6).

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chart 6, frugal investing
  • Automatic reinvestment: Ask your broker to automatically reinvest cash payments from stocks and investment funds.
  • Infrequent trading: Otherwise, frequent trading (especially small amounts of money on a daily or weekly basis) will dilute investment returns.
  • Low trading fees: Consult online ratings and reviews of brokerage firms to assess their trading fees.
  • Dollar cost averaging: The best way of compensating for fluctuations of market prices is to make monthly contributions to the investment account which will then purchase varying numbers of investment units (i.e., shares) depending on the market price. Dollar cost averaging requires a dependable source of money (e.g., payroll deduction, bank account) and a receptive account (e.g., direct deposit plan, 401-K, brokerage).
  • Taxes reduce the profits from investing. Here are several ways of protecting the profits from taxes:
    • The Kiddie tax defers some of a child’s investment returns from taxes.
    • Tax-efficient investments reduce the capital gains & dividends taxes (e.g., growth stocks) or state taxes on bond interest (e.g., muni-bonds).
    • Federal taxes are not charged on the profits from Roth retirement and Education Savings accounts.
  • Long term investing: stock prices rise and fall frequently during the short term, but in general the price of a stock will gradually rise in the long term. The young investor can expect a rise in stock price over 30-70 years.
  • Diversified investments: Some stocks fail to earn returns for the investor. Consequently, it’s a good idea to own several different kinds of stocks to protect the total investment.

“College” is a Big Project

“College” is defined as any 2-year, 4-year, or career school after high school graduation. College prep is a family enterprise that prepares the high school student to negotiate their admission to college. Negotiation is the bargaining process that occurs between the student who wants to attend a desirable college and the college who wants to admit desirable students. The student’s ideal financial goal is to balance the cost of college with family savings and scholarships. Financial aid is only used if needed (chart 7).

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chart 7, college prep

TIMELINE FOR COLLEGE PREP

  1. Family starts saving for college 15-18 years early with a “529 Plan” or “Coverdell account” owned by the parents. Grandparents can help fund the plan.
  2. Family has early discussions about college and the opportunities offered by a college education.
  3. Student starts seeking scholarships during the freshman year of high school. Start with the school guidance counselor and librarian. The family can help with the research, proof-readings, practice interviews, travel costs, etc.
  4. Student reduces the cost of attending college by earning college credit during high school.
  5. Family applies for financial aid during the senior year of high school.
    • FAFSA (Free Application for Federal Student Aid) is required by all colleges.
    • CSS Profile (College Scholarship Service Profile) is required by colleges that award non-federal aid
  6. Student negotiates the terms of college admission.
Quick references:

Protect them

In the event of a catastrophe, every household should have an emergency fund to sustain their budget for at least 3 months, preferably 6-9 months.

protect
chart 8, protect
More information:

In closing:

conclusions

 

Copyright © 2018 Douglas R. Knight

Personal investments

 

personal investments

Borrow:

Secured loans are based on a collateral asset such as the borrower’s property or financial account. The lender can take ownership of the collateral asset if the borrower fails to repay the loan.
Unsecured loans are based on creditworthiness of the borrower. Lenders usually rely on credit reports to assess creditworthiness. Credit card accounts and student loans are unsecured loans. Beware: Students can incur high debt by borrowing for extra years of college or to attend an expensive school.

Short-term ownership:

The short-term investor typically lends money to an investment fund (money market fund), bank (certificate of deposit) or government (Treasury Bills) on the condition that the borrower promises to pay it back with a small reward (called “interest”) at a specified time no longer than 1 year.

Long-term ownership:

Stocks are certificates of part-ownership in a company. Stockowners earn returns from dividends and capital gains. The expected long-term rate of return is an average annual rate of 7%.
REITs are real estate investment trusts that distribute 90% of the annual profit to shareholders. REITs earn profits from rental fees and real estate investments.
Bonds are contracts that guarantee scheduled payments of interest and repayment of the invested money. The expected long-term return is an interest rate of approximately 4%.
Investment funds are pooled investments, typically in stocks or bonds, which are owned by a group of investors. Shareholders earn profits from cash distributions by the fund and by selling shares of the fund at a higher price.  Shareholders lose money if they sell shares at a lower price than paid to make the investment.
Mutual funds and ETFs are registered investment funds governed by the Securities and Exhange Commission (SEC.gov) and Internal Revenue Service (IRS.gov).
529 Plans, Coverdell ESAs and Roth accounts are portfolios of government-regulated, tax-deferred investments.
Homes are illiquid assets, meaning that they are difficult to sell quickly for cash. Owners earn a profit or loss at the time of sale.

Reference: http://www.finra.org/investors/types-investments

 

Retirement savings

Retirement savings plans are increasingly used to supplement Social Security pensions. The 401(k) is the most common retirement savings plan offered by employers. What will happen to the future retirement income of young employees if their Social Security benefits are reduced or their employers suspend 401(k) matching contributions? The employee will then have to make up the savings deficit. It would help if they have their own long-term investing plan for retirement.

Imagine an investment in stocks that grows by multiples of 3, 30, and 90 times the original value during successive time periods of 18, 50 and 67 years. Helping a child make such an investment would help them retire in comfort IF that child learns how to manage the investment throughout adulthood. Homeschooling will help determine how well the youngster ultimately manages the investment.

Many of today’s retirees worry about a shortfall of lifetime savings. Children could avoid this future worry by starting a long-term investment in stocks that accumulates more than two million dollars.  Today’s formula is simple: Start early to make regular deposits in a Roth IRA that invests in a broad-market, stock-index fund. Then build the fund with payroll deductions.

Why aren’t there more millionaire retirees? Because of obstacles along the way; college, debt, taxes, and low income to name a few. Dedication and planning are needed to circumvent the obstacles. And here’s an idea for low income families: Help your child open a custodial savings account to accumulate sufficient funds for starting an investment account. Irrespective of family income, parenting skills can instill motivation, participation, and the investment habit in a growing child.

References

  1. Retirement plans for children: https://www.investopedia.com/articles/retirement/06/retirementforminors.asp
  2. Roth IRA for Kids: http://www.irakids.com
  3. Facts about retirement savings plans: http://www.pensionrights.org/factsheet-topic-areas/retirement-savings-plans
  4. IRS retirement plans: https://www.irs.gov/retirement-plans

Copyright © 2018 Douglas R. Knight