Advisors' Corner

Have you taught your children about investing?

Children mature at different rates so it may take time before they're ready to tackle concepts like portfolio creation and asset allocation. However, the basics of investing can be taught quite young. Before your kids start cruising the Internet to check company profiles, you should explain risk and reward.

Begin by helping children understand one of the most important factors of investing, risk vs. reward: risk is the possibility that an investment loses some or all of its value, while reward is the gain that an investment earns over time. 

Let's sketch a brief picture of two common investments: debt securities and stocks.

Stocks and Debt Securities

Stocks are a variable risk, variable return investment. On the whole, they are categorized as high risk and high return. Make it clear that many risks involved in stocks can't be predicted because corporate records can be tampered with or CEOs can lie; however, despite those outliers, the stock market has risen consistently in the last hundred years, offering healthy returns.

A bond is a low-risk, low-return investment. Typically, bonds pay a small amount over the prime interest rate and are backed by stable institutions (usually banks or governments). You can buy lower-rated bonds that offer better returns but they can default and you can't necessarily count on getting the income when expected. Given the complexity of these instruments, you may wish to start your child with stocks and explain that bonds become more important later in life. 

Keeping Your Child's Attention

Show your child what stocks you own. Interesting companies might get their attention — plane manufacturers like Boeing, sports gear specialists like Nike, technology companies like Apple — look at the company's investor relations page with your child to learn how much they earned, what they make and how many people work for them. Then ask your child what company he or she would like to buy. Kids have favorites even if they are not aware of them. For example, Facebook and Disney are popular with most children. 

Once you have introduced your kids to basic concepts, sit down and let them select a company. If you have the money, buy the stock and look at it at least once a week to show how investments can rise or fall. If you don't have the money, make a model online portfolio and track stocks for fun. 

If you pick stocks with your children when they are young, they'll get a sense of the market's up-and-down cycles; this will prepare them for dealing with market fluctuations and help them make informed decisions when they grow up.

Letting Children Invest

When your child is older, you can provide a more in-depth explanation of stocks and other investments. Eventually, you want to let your children buy their own stocks. Your child may have enough cash diligently saved up in a savings account by the time he or she is interested in investing. Don't put it all into a bond or the stock market, but invest a third in each and keep a third in savings. This will allow your child to compare the returns of different types of investments.

You have two options if your child doesn't have money to participate in the learning process. You can use your own cash to open a small brokerage account for your child to make investments or build a model portfolio of stocks that your child wants to buy someday. In the latter case, you will need to find innovative ways to maintain their interest. 

Allow your child to make real decisions and take real risks. Money may be lost but the purpose of the exercise is to familiarize them with investing and part of this process is learning that investments have advantages and disadvantages. Whatever the outcome, the experience of gaining and losing money will be valuable.

Learn more about teaching kids about money management and explore other family finance topics by visiting our Parent Resource Center. 

Parent Resource Center

This article was shared from it's original posting on Investopedia.com. View original article here. 

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