Editors' pick: Originally published April 29.
Your teen grew up in the age when “saving” really meant “investing” and every grown-up who was building a nest egg kept an eye on Wall Street. What do these budding adults comprehend about investing – and what’s the best way to teach and them?
“It’s a common inquiry I get from high school and college students,” says Taylor Schulte, CEO of Define Financial in San Diego. "But rather than, ‘What should I invest in?’ I’d like to see them first learn to develop a process and a plan around an investment strategy.”
“There are lots of teens interested in investing,” adds Sophia Bera, financial advisor and founder of Gen Y Planning, “but [to them] it seems like this mythical thing, like unicorns. They want to know how it works.”
Naturally, teens gravitate toward stocks with names they know, such as technology companies like Apple (AAPL) - Get Report or, according to the latest “Taking Stock With Teens” research survey from Piper Jaffray, the likes of Nike (NKE) - Get Report , Adidas (AG) - Get Report and Starbucks (SBUX) - Get Report .
A good start for teens is to invest in things they know and understand, according to Schulte. “What products do you use daily?" Schulte says. "Where do you shop? If it happens to be technology, then great. This exercise will often result in [finding] large companies that we all know by name. For instance, Apple or Microsoft (MSFT) - Get Report .
That's a good exercise, but, Schulte adds, “the teen will likely end up with only a few companies to invest in, which might not be prudent diversification. The next step would be to find a low-cost mutual fund or exchange traded fund that owns some or all of the stocks.”
“Certain sectors are more exciting and relatable for teens, such as technology, and these can be used as examples for illustrating important investing concepts,” says Rafia Hasan, director of investment at Wipfli Hewins Investment Advisors in Chicago. “It is exciting to pick individual stocks, and sometimes that can be the basis for starting a conversation around investing. But investing in a handful of stocks or a single sector is risky. Diversifying risk is one of the most important tenets of a smart investment portfolio – and a concept teens should learn early.”
One of Schulte’s first questions to teens: “What’s the difference between a stock and a bond? Many assume that we just invest in the stock market, but that’s not true. Bonds and other asset classes play a big role in a portfolio for investors of any age.”
Other basic terms helpful for new investors: asset allocation, index fund, dollar cost averaging and dividends, among many others. “Once you get more comfortable with the basics, you can start to expand into more complex terms,” Schulte says, “such as expense ratio, P/E ratio, alpha, beta and standard deviation.”
Among the must-know terms on Bera’s list for young investors:
Stocks: Shares of a public corporation, so you can take partial ownership and profit off of the company’s earnings.
Bonds: A debt security where the investor lends to government or corporate entities. In exchange, those entities provide interest payments at predetermined intervals and pay back the loan in full.
Money market account: A type of savings account offered through many banks and credit unions that pays slightly higher interest but also may require higher account balances or come with other restrictions.
Mutual fund: A pool of money from several investors to buy stocks, bonds or other securities to be managed by a professional fund manager.
Diversification: Holding varied investments such as stocks (especially of companies in different industries and fields), bonds and money market funds to minimize risk.
The blog Frugal Rules lists the six best investing books for beginners: A Random Walk Down Wall Street by Burton Malkiel; The Bogleheads’ Guide to Investing by Taylor Larimore, Mel Lindauer and Michael LeBoeuf; The Intelligent Investor by Benjamin Graham; The Richest Man in Babylon by George Clason; Common Sense on Mutual Funds by John Bogle; and If You Can: How Millennials Can Get Rich Slowly by William Bernstein.
Teenagers need to learn two initial points about investing: “Stay focused on the things you can control, and you can’t beat the market over a long period,” Schulte says.
“The hardest part about investing is the deferral of gratification,” Hasan says. “To invest, you have to forgo spending on things you might want today, such as that video game or that pair of cool sneakers. But by waiting and putting your money into something that will grow, you can potentially buy more or better stuff later – like a mansion.”