Smart Saving And Investing Strategies For Your Kids' Future

It's never too early to start learning about money, and that includes kids, too. While they might not be ready to tackle portfolio creation and asset allocation, they can certainly grasp the basics of investing, and it's never too early to start saving.

There are plenty of ways to introduce kids to the world of finance, from opening a savings account to investing in stocks and shares. The earlier they start, the more likely they are to develop better financial habits and build wealth over time. And it's not just about the money, either – it's about giving kids the knowledge and skills they need to make informed decisions about their finances as they get older and achieve financial freedom.

So, where to start? Well, it's probably a good idea to begin with basic financial concepts like saving and spending. Once they've got to grips with that, you can move on to the basics of investing, including explaining that a stock – or share of a company – means they'll have ownership in that company. You can also teach them about the relationship between risk and reward, and the difference between high-risk, high-return stocks and low-risk, low-return investments like bonds.

If you want to give your kids a more hands-on lesson, you can let them pick out a stock and either buy a few shares for them or set up a model portfolio so they can make trades without spending real money. And if you want to get them interested, try teaching them about popular companies like Nike or Apple, or choose companies that match their interests – Disney is always a good option!

There are also lots of books out there that can help kids learn about saving and investing, like *What All Kids (and adults too) Should Know About Savings and Investing* by Rob Pivnick, which covers everything from compounding and saving to budgeting, debt, setting goals, and even negotiation.

So, are you ready to teach your kids about saving and investing? It could be the best financial decision you ever make!

The importance of saving and budgeting

Saving and budgeting are important skills for children to learn as they form the foundation for future financial success. By understanding the basics of money management, children can develop good financial habits that will benefit them throughout their lives. Here are some key reasons why saving and budgeting are essential:

• Developing Good Saving Habits: Teaching children about saving and budgeting from a young age helps them understand the value of money and the importance of financial responsibility. They learn that money is earned through work and is necessary for meeting basic needs such as food and housing. This encourages them to spend wisely and save for future goals.
• Understanding Risk and Return: Investing involves risk, and it's crucial for children to grasp this concept early on. Some investments offer low risk with low returns, while others, like stocks, come with higher risk but potentially higher returns. By investing small amounts, children can experience the impact of risk and return firsthand and develop their risk tolerance.
• Compound Returns: Starting to save and invest early allows children to take advantage of compound returns over time. Even small amounts of money saved and invested at a young age can grow significantly by the time they reach adulthood, setting them up for a more secure financial future.
• Financial Security: Encouraging children to save and budget wisely can help them achieve financial security sooner. By saving aggressively from a young age, they can build a substantial nest egg that will benefit them in the long run, whether it's for retirement, buying a home, or pursuing other financial goals.
• Budgeting and Goal Setting: Budgeting is an essential skill that goes hand in hand with saving. Teaching children how to budget their money, set financial goals, and differentiate between needs and wants empowers them to make informed financial decisions.

By prioritising saving and budgeting education, parents and caregivers can give children a strong foundation for their future financial journey. It helps them develop a healthy relationship with money and makes them more likely to make wise financial choices as they grow up.

How to invest

Before you begin investing for your children, it's important to ensure your own financial stability. This means being debt-free (excluding your mortgage), having an emergency fund, and investing in your retirement first.

There are several options for investing in your child's future, each with its own advantages and limitations. Here are some of the most common ones:

• Custodial Individual Retirement Account (IRA): This is a great way to give your child a head start on retirement, especially if they are earning some money. You can open a traditional or Roth IRA, but a Roth IRA is generally recommended due to its tax advantages.
• Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minor Act (UTMA) accounts: These accounts allow you to invest in growth stock mutual funds and offer certain tax advantages due to the lower tax rate for children. However, your child will gain full control of the account at a certain age, usually between 18 and 25.
• Brokerage Account: If you want more control over the funds, you can open a brokerage account in your own name and invest until you're ready to gift the money to your child. While this option offers flexibility and no contribution limits, you'll have to pay capital gains taxes based on your tax rate.
• 529 Plan: This is a tax-friendly account specifically for saving for your child's education. Contributions are not federally tax-deductible, but most states offer tax breaks, and withdrawals for qualified education expenses are federal income tax-free.
• Education Savings Account (ESA) or Coverdell Savings Account: This is another option for saving for education, with a maximum investment of $2,000 per child per year. However, there are income limits for contributions.

When teaching your children about investing, it's important to cover the basics first. Explain the relationship between risk and reward, introducing them to the concepts of stocks and bonds. You can use popular companies like Nike, Apple, or Disney to spark their interest.

As they get older, you can let them pick out a stock and either buy a few shares or set up a model portfolio for them to make simulated trades. Encourage them to invest in a mix of stocks, bonds, and a savings account.

In addition to the above, here are some other key points to consider:

• Allowances: Avoid counting allowances as earned income when contributing to an IRA.
• Financial Literacy: Teach your children about money, money management, and investing early on. This will help them develop good financial habits and make more informed decisions in the future.
• Communication: Be transparent with your children about your financial gifts and the expectations you have for how the money should be used.
• Financial Gifts: Be mindful of gift and estate tax implications when giving financial gifts to your children.
• Timing: The earlier you start investing, the more time your investments have to grow and benefit from compound interest.

Different types of investments

There are several types of investments that can help children save for the future. Here are some of the most common ones:

Custodial Accounts

A custodial account is a type of investment account that is opened and managed by an adult on behalf of a minor. The money in the account is considered a gift to the child, and it can be used for various purposes, such as education or future expenses. There are two main types of custodial accounts:

• Uniform Gifts to Minors Act (UGMA) accounts
• Uniform Transfers to Minors Act (UTMA) accounts

These accounts offer certain tax advantages, as they are taxed according to the child's lower tax bracket. However, it's important to note that once the child reaches a certain age, they gain full control over the account and can spend the money as they wish.

Brokerage Accounts

A brokerage account is opened in the parent's name, giving them more control over the funds. This type of account offers flexibility, as there are no contribution limits, and the money can be withdrawn at any time without penalty. However, the parent will have to pay capital gains taxes based on their tax rate.

529 Plans

A 529 plan is a tax-advantaged investment account specifically designed for saving for education expenses. The money in the account can be used for qualified education expenses, such as tuition, books, and fees. While contributions are not federally tax-deductible, most states offer tax breaks, and the money in the account grows tax-deferred. Withdrawals made for qualified education expenses are also federal income tax-free.

Custodial Individual Retirement Accounts (IRAs)

A custodial IRA is a retirement account opened in the child's name. This type of account is suitable for teenagers who are earning some money and want to start saving for retirement early. The parent manages the account until the child reaches the age of majority, usually 18 or 21. A custodial IRA can be either a traditional IRA or a Roth IRA, with the latter offering tax-free growth on the savings.

Certificates of Deposit (CDs)

While not technically an investment, certificates of deposit (CDs) are worth mentioning as a low-risk option for saving. CDs are offered by banks and typically provide a fixed interest rate over a predefined term. They are less liquid than savings or money market accounts but often offer higher rates of return.

How to manage money

Saving and budgeting

Saving is an important habit to develop from a young age. Explain that money is earned through work and is needed for essentials like food and housing. You can teach children about budgeting by giving them an allowance that they must save up to buy the things they want.

Investing

Investing is a way to make your money grow. You can invest in many things, but two of the most common investments are stocks and bonds. Stocks are high-risk but offer the potential for high returns, while bonds are low-risk, low-return investments. For example, stocks can increase in value if the company performs well, but negative news can also cause the stock to lose value. Bonds generally pay a small amount over the prime interest rate and are backed by stable institutions.

Risk and reward

It's important to understand the relationship between risk and reward when investing. Stocks are considered high-risk because their value can fluctuate, while bonds are low-risk because they are backed by stable institutions. However, the potential returns on stocks are higher than those on bonds.

Different types of accounts

There are several types of accounts that can be used for saving and investing, including:

• Savings accounts: These are offered by traditional or online banks and allow you to easily deposit money. They typically have no minimum balance requirement, no monthly fees, and offer a competitive interest rate.
• Certificates of deposit (CDs): CDs offer a fixed interest rate over a predefined term and are less liquid than savings accounts. They are suitable for those who can leave their money invested for longer periods.
• Custodial accounts: These accounts allow an adult to invest money on behalf of a child. Any contributions are considered an irrevocable gift and assets can only be withdrawn to benefit the child. The adult retains control of the account until the child reaches a certain age, typically 18-25.
• Brokerage accounts: These accounts offer more control and flexibility than custodial accounts, as the account owner can access and manage the money at any time. However, they also come with higher taxes.
• Retirement accounts: While typically associated with adults, retirement accounts like Roth IRAs can also be used to save for a child's future, provided they have earned an income. These accounts offer tax advantages and the potential for compound interest over time.

The risks and rewards of investing

Investing is a great way to build wealth over time, but it comes with its own set of risks and rewards. Understanding the relationship between risk and reward is crucial for making informed investment decisions.

Stocks, for instance, are considered high-risk investments. Their values can fluctuate due to various factors, such as company growth, profitability, or negative news. While investing in stocks may lead to significant returns, it is also possible to incur losses. On the other hand, bonds are generally low-risk and low-return investments, often backed by stable institutions. They offer a small but relatively safer return compared to stocks.

When investing, it's essential to assess your risk tolerance and investment goals. Diversifying your portfolio by investing in a mix of stocks, bonds, and other assets can help balance the risks and rewards. Additionally, investing for the long term can smoothen out short-term losses and market volatility.

One of the benefits of investing for children is the power of compound returns over time. Even a small amount of money invested at a young age can grow significantly by the time they reach adulthood or retirement. This highlights the importance of starting early and taking advantage of time in the market.

However, investing also comes with the risk of losing money. It's important to remember that not all investments will be profitable, and there may be times when the value of your investments decreases. As a parent, it's crucial to weigh the risks and rewards of different investment options and make informed decisions on behalf of your children until they are old enough to understand and manage their investments independently.

In conclusion, investing involves navigating the risks and rewards of different assets. By understanding the basics of risk and return, children and their parents can make more informed decisions about saving and investing, ultimately setting them up for a secure financial future.

Frequently asked questions