By Kiyosha Baird
Investing is the ultimate way to build wealth over time. Investing basics for kids lays the foundation to start investing. Empowering kids to become captains of their financial destiny by giving them the know-how and capability to build wealth.
Let’s get started.
What is Investing?
Investing is a special type of spending. It’s the process of buying appreciating assets.
An asset is something that has value.
An appreciating asset means its value increases over time.
So, how can you tell if you’re spending or investing?
By observing your financial worth over time.
For example, consider buying a $30 video game.
The game is an asset, but it is not a very valuable asset. Why? Because it tends to decrease in value over time, or depreciate, especially as new editions are released.
By extension, it’s unlikely you will be able to sell the video game for the $30 you bought it for. Instead, you will likely sell it for less. This type of spending is not investing because you are not growing your overall worth.
Instead, imagine you buy stock, partial ownership in a company, for $100; a year later, it’s worth $150.
Because of appreciation, your stock increased by $50 without additional effort. You grew your financial worth because your asset became more valuable. That’s what makes investing so amazing.
Now that you know what investing is, let’s explore who invests.
Who is an Investor?
A person who owns appreciating assets is called an investor.
Investors have a certain mindset when buying assets, which helps them select assets that appreciate. And avoid assets that lose money.
Three ideas shape an investor’s mindset.
Idea 1: Investors Expect a Return
Because investors spend money to buy assets, they expect to earn more than they spend. This is called a return on their investment. In essence, the investor expects to profit or make money from the asset.
Idea 2: Investors Manage Risk
However, each asset carries a risk that an investor could lose money. An investor’s mindset is to reduce that risk.
There are many ways to reduce the risk of losing money. One way is to determine one’s risk tolerance.
Risk tolerance is the amount of risk an investor is willing to take when buying an asset. It ranges from low-risk or conservative opportunities to high-risk, aggressive opportunities. An investor who knows their comfort level with risk will be better able to select the best investment opportunities.
Idea 3: Investors Understand the Relationship Between Return and Risk
The higher the risk, the higher the return. The opposite is true: the lower the risk, the lower the return.
Investors understand these dynamics.
With this understanding, investors seek to balance return, also known as reward, and risk. They accomplish this by buying assets with risk-reward profiles that fit their investment goals and risk tolerance and by diversifying their assets.
Diversification is holding different asset types. Let’s look at some common investment assets investors use to diversify.
What are the Most Common Types of Investment Assets?
There are many different types of investment assets. Here are some of the most common assets from low to high risk.
Cash
Risk: Very Low
Return: Very Low
Return Type: Interest
Most kids’ first asset is cash. Cash is a flexible asset in that it can be easily exchanged for other goods, services, and assets. From chore earnings to birthday money, the sources of cash are many.
While cash is vulnerable to loss or theft, these risks can be prevented if deposited at a bank or credit union. Deposited cash has another advantage. It earns interest. However, the earnings are very low compared to other investment options.
Certificates of Deposit (CDs)
Risk: Low
Return: Low
Return Type: Interest, Principal
A certificate of deposit, or CD, is a financial product that banks and credit unions offer. This special savings account requires investors to make an initial deposit and hold the investment for a fixed period.
During the CD’s term or fixed period, the investor agrees not to withdraw any money. Terms could range from three months to more than twelve months.
However, the interest you earn in a CD is generally higher than you would receive by holding money in a savings or checking account.
If you have some extra cash you won’t need for a while, a CD is a great, low-risk way to start investing.
Bonds
Risk: Low
Return: Low
Return Type: Interest, Principal
A bond is a loan to an entity, such as a company or a government. Like any loan, the investor receives interest and, eventually, the repayment of the initial investment, called the face value or principal.
While investors do not receive ownership rights, bonds have other advantages. As a lower-risk investment, it is more predictable than other higher-risk assets.
Bonds, like CDs, also generate income in the form of interest. However, unlike CDs, bonds often require a higher initial investment.
A bond may be a good option if you prefer to receive predictable income from your investment.
Real Estate / Property
Risk: Moderate
Return: Moderate
Return Type: Rental income, Appreciation, Tax Advantages
Owning real estate is another classic asset category.
In real estate, property opportunities are divided into commercial (office buildings, warehouses etc) and residential (homes, apartments, etc).
You can own property directly. Or, you can own a share or portion of the property through a REIT, Real Estate Investment Trust. REITS can be more affordable than buying properties directly, but you also share ownership with other investors as a trade-off.
Real estate provides a return through rental income, appreciation, and tax advantages. However, it is a less flexible asset and expensive to acquire and maintain, making it a more moderate investment asset.
Stocks
Risk: High
Return: High
Return Type: Appreciation, Dividends
For public companies, you can buy shares of the company’s stock. A share represents a partial ownership interest in a company. Nike, Roblox, McDonald’s, and Amazon are all publicly traded companies. And there are thousands more domestically and internationally.
In addition to purchasing individual stocks, stocks can be purchased as a group. Examples of a group of stocks, also known as equity investments, include index funds, mutual funds, and exchange-traded funds (ETFs).
However, stocks are considered highly risky because the underlying asset, the business, is subject to many pressures, like competition. With greater risk comes greater reward. And those rewards are in the form of stock appreciation and dividends.
Assets are unique. Like fingerprints, each type carries its own risk-reward profile. By understanding the asset profile, investors can balance the risks and rewards through diversification.
Now that you understand the more common asset types, let’s explore considerations for becoming an investor.
Am I Ready to Invest?
At this point, you may be interested in becoming an investor. A great way to prepare is to ensure your financial foundation is in place.
Here are three indicators that you may be ready to start investing.
You Have an Emergency Fund
This is very important because you may lose money while investing. However, having an emergency fund provides a safety net against these losses and helps you meet your daily spending needs.
You Use a Budget
Having a budget lets you know your spending needs and savings levels. After your living expenses are met, it will also let you know if you have any extra money after savings to put towards investing. Resources used for investing should be separate from those dedicated to meeting day-to-day expenses. Having this separation will reduce pressure if losses occur.
You Have Low or No Debt
Carrying high debt, especially consumer debt like credit cards, takes resources away from investing. If you have high debt, focus on repaying your debts first. When you have reached a comfortable debt level, begin repurposing resources towards investing.
These three foundations will help position to become and investor and begin investing with greater confidence and less risk.
How Do I Start Investing?
You’ve decided to start investing. How do you get started?
If you want to invest in stocks or bonds, you will need to open a custodial account.
A custodial account is an investment account owned by a child but managed by an adult or custodian until the child is 18 or 21. At that point, management transfers from the custodian to the child.
Investment companies or brokerages offer these types of accounts. Examples of brokerages in the United States are Fidelity, Vanguard, and Charles Schwab. However, every country has brokerage companies.
There are two types of custodial accounts for kids: the Uniform Gifts to Minors Act, UGMA, and the Uniform Transfers to Minors Act, UTMA. Both accounts are very similar. The main difference between these accounts is UGMA is limited to financial products such as stocks, mutual funds, bonds, cash, insurance policies etc. However, the UTMA is broader and can also hold property.
Two advantages of custodial accounts are that children can work with the custodian to get hands-on experience in investing, and investment income is often taxed more favorably than a traditional brokerage account.
Two disadvantages are that contributions are considered irrevocable gifts and could significantly affect the financial aid of college-bound students, and once the child gains full control of the account, they may use the funds for any purpose, which may or may not align with parent’s intentions.
However, the advantages far outweigh the costs.
Opening the account is like opening a savings or checking account at the bank. However, a child can’t open the account on their own. They will need help from an adult who will be the custodian.
Specifically, the custodian will need to provide the information to open the account. Some of that information may include the child’s name, birthday, social security number, and their own social security number to the financial institution of choice. Once the account is opened, it will need to be funded, and then the custodian can begin buying assets, like stock and bonds.
Conclusion
Investing basics for kids covers the foundational concepts need for investing. From connecting investing to spending, to defining an investor and various types of assets, to how to get started investing, this knowledge builds kids’ capacity to build wealth.
Take the next step, open a custodial account for the child in your life today.