How to teach your kids to invest

How to teach your kids to invest

Teaching children to invest is a daunting prospect, but it could be one of the most valuable lessons they learn. Our relationship with money starts to form early. As children, we observe how those around us utilise their resources, which helps shape our attitude to money. 

Parents have the opportunity to teach their kids to have a healthy relationship with money. By developing good financial habits early on, parents can set their kids up for a lifetime of sound financial decisions. This can pay dividends by enabling your kids to achieve things such as home ownership, a share portfolio, and comfortable retirement.

According to recent research, about 270,000 Australian kids have a share trading account in their name. Starting an investment fund early is a good way of introducing children to the concept of investing, teaching them about compound returns and wealth accumulation over time. 

While you need to be aged over 18 to buy and sell shares, parents can open accounts in their children's names and can hold shares in their own names for the benefit of their kids. 

Investing with your kids is a great opportunity to enhance their financial literacy, and teach them about important concepts, such as diversification.

Why is it important to teach your kids to invest?

A person’s relationship with money can be a determining factor in their success. Having a healthy relationship with money assists in building personal wealth, which allows for greater opportunities and a more comfortable lifestyle. 

Parents are in a position to exert significant influence over their children’s relationship with money. This influence can be passive, occurring as kids observe their parents managing their own money. It can also be active, where parents take time to educate their kids about financial matters and the different ways money can be utilised. 

When we invest on behalf of our children, our intention is to grow those funds to provide them with greater assets. Ideally, our kids would continue to grow those funds, maximising the benefits of compounding that accrue over time. If we want this to occur, we need to educate our kids about investing and money management. 

Children should be in a position to utilise financial products to their advantage, but to do so, they need to understand how these products work. If you’re a seasoned investor, investing for your kids might be relatively straightforward. But investing with them? Teaching them the fundamentals they need to know to make smart investment decisions? That’s the hard part. 

While challenging, educating our children about financial matters is well worth it. As Benjamin Franklin said, “An investment in knowledge pays the best interest”. 

Practical financial education is frequently overlooked in the school curriculum, meaning parents have an even more important role to play to ensure their kids’ financial literacy. Making sure your children are equipped with a fundamental financial education gives them the tools to take control of their financial future. 

Understandably, many parents themselves lack confidence in their financial knowledge. In 2021, the Federal Government conducted the first biennial national financial capability survey, which found that Australians have a financial literacy score of 68/100. Young people aged 18-24 years scored just 50/100. 

This is a concern considering the complexity of financial markets and the easy credit available to young people. To ensure our kids are equipped to navigate the financial world, parents must take the time to educate themselves and their children. Kids learn by imitating the behaviour of those around them, so it is important that parents model good financial management skills. 

The power of compounding means the earlier young people start investing, the more time they will have to grow returns. Compounding occurs when returns are reinvested, so that returns are earned on returns. Over time, this can lead to significant growth in the value of investments. 

Compounding can play a pivotal role in growing wealth but requires time to take effect. This is why getting kids involved in investing early is ideal. Over time, they will have the opportunity to learn crucial financial skills and knowledge while the power of compounding grows their initial investment. 

How to motivate your kids to invest

Some kids may require some convincing to learn about investment. Thankfully, there are plenty of examples you can use to show them the value of starting early. 

Take Warren Buffett. He is now the world’s fifth-richest person but he started investing at age 11 with cash earned from his paper route. His wealth has increased exponentially over time thanks to the power of compounding. He was worth an estimated $1 million at age 30 and $1 billion by age 56. Now, at 91 years old, he is worth more than $100 billion. 

You can explain the concept of passive income to children by relating it to something they enjoy. If they are into video games, ask them to imagine which games they would buy if they were paid dividends. This can help kids see the value of passive income in a concrete way. 

It can also be helpful to relate investment concepts to kids’ everyday experiences. If your kids love Apple products, explain that you can buy shares in Apple Inc (NASDAQ: AAPL). Apple shareholders receive the profits from the Apple products people buy. 

When you take your kids to the supermarket, you can explain that both Coles Group Ltd (ASX: COL) and Woolworths Group Ltd (ASX: WOW) are listed on the ASX. Each beep of the checkout represents money paid to the owners of the business – the shareholders. 

Educate your kids on the different types of businesses they can invest in. Have they shopped at a Smiggle or Peter Alexander store? Then they are a customer of Premier Investments Limited (ASX: PMV), which is also behind Just Jeans, Jay Jays, Dotti, and Portmans. 

More the outdoors type? Then they might be interested to know that Boating Camping Fishing is owned by Super Retail Group Ltd (ASX: SUL). 

Do your kids use buy now, pay later services to finance their purchases? If so, they would have heard of Zip Co Ltd (ASX: Z1P). With more than 2,000 shares listed on the ASX, there are plenty of businesses you can invest in that may pique your kids’ interest. 

Keep it playful, too. You can make a game out of picking shares and monitoring their performance over different time periods using watch lists on asx.com.au or your online share trading platform. 

The ASX also runs free 15-week Sharemarket Games on its website, giving players $50,000 of virtual cash to buy and sell shares in more than 300 companies and 55 exchange-traded funds (ETFs). The game uses live prices, and brokerage is charged on every trade, just like in real life. 

Because investing is a long-term game, it is important to keep kids interested over the long haul. This means making time to regularly review the shares you are following and how they are performing. 

Checking the share price is one thing, but to really understand what influences performance you need to go deeper. Company reporting can be reviewed for insights into each business and their future plans. This information is publicly accessible on asx.com.au, online share trading platforms, and company websites, so take the time to investigate it with your kids.

Investing for your kids and tax

Before you get started investing for your kids, it is important that you understand the tax implications. These will depend on how the investment is structured. You can buy shares on behalf of your kids – with the parent/s as the trustee and the children treated as beneficiaries – or you can choose to purchase them in your own name and hold them for your kids’ benefit until they turn 18. 

When you buy shares, you have the choice to quote a tax file number (TFN). If you do not quote a TFN, pay-as-you-go (PAYG) tax will be withheld at a rate of 47% from any unfranked dividend income earned on the shares. Children can apply for a TFN (there is no minimum age) and are not exempt from quoting it. 

Special rules apply to income earned by people aged under 18, and some income may be taxed at a higher rate than for adults. For under-18s, non-excepted income is taxed at 0% for the first $416 earned, then 66% for amounts between $417 and $1,307, and 45% for amounts in excess of this. 

Any income received by your children in dividends or capital gains on the sale of shares will be non-excepted income and hence subject to these tax rates. 

If your child owns shares and earns more than $416, you will need to lodge a tax return on their behalf. If they earn less than $416, you may still want to lodge a tax return to claim any available refunds for franking credits

Obviously, you will want to avoid paying onerous tax rates on income earned through your kids’ share investments. One way of doing so is to minimise the amount of dividend income received. 

To earn dividend income of $416 annually, kids would generally need to hold $10,000–$15,000 in dividend-paying shares. While many would not expect to exceed this initially, as share prices and dividends grow over the coming years, limits could be tested. 

Another option is to invest in high growth companies that pay minimal or no dividends. This minimises the tax impact of dividends, while the potential growth in the share price is unlimited. Any capital gain made if the shares are sold would be income, but the idea is not to sell. The aim is to buy quality companies that you and your kids will be happy to hold for years. 

Shares held on behalf of your kids can be transferred to them when they turn 18 via an off-market transfer. Provided the beneficial owner has not changed, there shouldn’t be any capital gains tax implications. 

How to open a brokerage account for kids

There are a number of different options when it comes to opening a brokerage account for your kids. SelfWealth has introduced kids’ accounts that enable minors under the age of 18 to be nominated as beneficiaries. 

CommSec allows you to open an account in the name of an adult, who will act as trustee until the minor turns 18. Then, the shares can be transferred to them via an off-market transfer. 

Parents can always buy shares in their own name and hold them in trust for their kids. Parents can use their own brokerage account to do so, they just need to keep a record of which shares belong to who. Doing this can be as simple as keeping a spreadsheet. Parents who buy shares in their own name can use whichever share trading platform suits them. Share trading platforms are offered by the major banks as well as competitors, such as CMC Markets.  

Micro investing applications such as Raiz could be worthwhile if you are investing small amounts of money. These applications can help you avoid outsized brokerage fees and allow for the investment of pocket money-sized contributions. Investment options are more limited and may be confined to ETFs, but micro-investing can allow your kids to dip their toes in the investment waters.

What should kids invest in?

Kids have the luxury of a long time horizon when investing. This gives them time to ride out (and take advantage of) multiple market cycles. Because of this, growth investing can be a good option. This means investing in growth shares – that is, young or small companies whose earnings are expected to increase at an above-average rate. 

Buying shares in emerging companies can provide impressive returns (provided the companies succeed) but can be high risk. This is one of the reasons why diversifying your kids’ investments is important. It’s the same principle as not putting all your eggs in one basket. By spreading your investments across a number of companies, you decrease the overall risk of your portfolio. 

ETFs can be a great place to start for kids. Because ETFs give exposure to dozens of underlying companies, they provide instant diversification. Thematic ETFs may align with your kids’ own interests. For example, there are a number of ETFs available on the ASX that focus on sustainable and ethical investing, or cover companies that are actively addressing climate change. 

Kids can go global with ETFs, or choose region-specific ETFs allowing for investment in companies from Asia to Europe. Industry-specific ETFs can provide exposure to companies in specific sectors, such as the resources sector and financial sector. 

Children might be interested in ETFs with a focus on technology, such as those providing exposure to the NASDAQ or Australian All Technology Index (ASX: XTX). There are also ETFs that provide exposure to the global cybersecurity sector, and to robotics and artificial intelligence companies. 

Using ETFs can help balance the need for diversification with keeping your kids interested. As their knowledge develops, you can let them have a go at picking individual companies they are interested in. 

Let them research these companies and come to you with an investment recommendation based on their work. This gives them a chance to spread their wings but also ensures you are involved in vetting any potential investment decisions. 

How do I keep my kids interested in investing?

Getting children started on the investment journey can be an exciting time, but what happens when their attention starts to wander? Investing is a long-term game. Kids also benefit from a long-term approach to financial education. 

Setting just a small amount of time aside each week or month can add up to a wealth of knowledge over time. This will serve your kids well as they begin to manage their own money. Keep them involved in monitoring investment performance, tracking share prices online, and following news about companies of interest. 

It can be helpful to start with companies that children already have exposure to. Most kids will be familiar with Apple products, so this can be a jumping-off point for a wider discussion. Ask your kids what they think about the latest iPhone release and how it will impact the company – their answers may surprise you!

Conversations about financial matters need to be pitched at a child’s level of understanding. Start with the basics and build from there. Over time, as their knowledge and (hopefully) interest grows, more complex concepts can be introduced. Involve kids in discussions about company news, such as the latest product releases, mergers and acquisitions, and earnings highlights. 

While it might be a bit much to expect kids to start reading profit and loss statements, they can learn basic financial metrics and how these measure business performance. 

Take the opportunity to review company results at a level that is appropriate for your child. Company reporting seasons provide a regular opportunity to take stock of investments as well as educate kids about investing.  

As children grow and their interests develop, their investments should develop with them. Investing in areas they are already interested in can make it more likely that they will take an active role in monitoring them. 

Some kids may be interested in fashion or retail, so you could look to ASX shares such as Accent Group Ltd (ASX: AX1) or Lovisa Holdings Ltd (ASX: LOV). Other kids may be into technology, so you could consider ASX shares like Altium Limited (ASX: ALU) or Life360 Inc (ASX: 360). 

Foodie kids could be interested in shares like Domino’s Pizza Enterprises Ltd (ASX: DMP) and Collins Foods Ltd (ASX: CKF), which has KFC and Taco Bell operations in Australia and Europe. 

Those who are into sport may be interested in Catapult Group International Ltd (ASX: CAT), a sports performance analytics company. As discussed above, there is also a wealth of ETFs traded on the ASX that can provide both broad and specific exposures. 

Ultimately, children will have to make their own financial and investment decisions once they’ve grown up. In the meantime, we can equip them with the skills they need to make good decisions. A sound financial education gives kids a strong base from which to grow and can lead to greater financial freedom in the long term. 

We invest throughout our lives – in our homes, our superannuation, our careers, and our relationships. Whether we succeed in those investments has a massive impact on our lives. In these circumstances, it only makes sense that we teach our kids about investment. 

Although this can be daunting, the key thing is to get the conversation started. By introducing your kids to the basics of investing and financial products early in life, you will give them an invaluable advantage.

 

All figures are correct as at 23 March 2022. Motley Fool contributor Katherine O'Brien owns Altium and Apple. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns and has recommended Altium, Apple, Catapult Group International Ltd, Collins Foods Limited, Life360, Inc., Super Retail Group Limited, and ZIPCOLTD FPO. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool Australia owns and has recommended COLESGROUP DEF SET, Catapult Group International Ltd, and Super Retail Group Limited. The Motley Fool Australia has recommended Accent Group, Apple, Collins Foods Limited, Dominos Pizza Enterprises Limited, Lovisa Holdings Ltd, and Premier Investments Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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