How to Help Your Child Invest in the Stock Market

It is great to start children investing when they are young. A child who has learned the power of saving and investing early will most likely do better at saving and investing than one who has not. In addition, if you yourself are an experienced investor, you will be able to give your children some hands-on experience with you looking over their shoulders before they are out on their own.

This article will not go into the mechanics and rules in setting up a brokerage account for a minor. That advice is best left to an expert in tax law. Suffice to say that starting with a good broker to set up the account, and then consulting with a good CPA on the tax implications would be wise. You should expect to set up a Uniform Gift To Minors (UGTM) account with yourself and/or your spouse as custodian. There should also be little or no taxes in the early years since capital gains and dividend taxes only start above a certain threshold.

Once an account has been set up and funded (again, check with a CPA to avoid paying gift taxes), it is time to start working with your child to find initial investments. At this point the choice should be made as to whether to have them start investing in individual stocks, mutual funds, or perhaps a combination of each. This is really an individual choice, depending on your (and your children's) tolerance for risk when it comes to handling money. They are really in an ideal point to start investing in individual stocks since they have a long time horizon to make up for any early mistakes. There would certainly be nothing wrong, however, to simply start investing in mutual funds and stick with it, perhaps adding a few individual stocks once a substantial portfolio is built. This article will only cover mutual funds since covering both would be too lengthy.

If the choice is made to start investing in mutual funds, the rest is really simple. A set of five funds should be selected that have different investment strategies. For example, a set that includes a growth fund, a value fund, an international fund, an aggressive growth fund, and a growth and income fund could be one selection. Another strategy would be to find a large cap, mid cap, small cap, international, and aggressive growth fund. Yet another set would be a large cap stock fund, a small cap stock fund, a REIT fund, a growth and income fund, and an international fund. A primary reason for choosing a fund should be the total cost (minimize loads and yearly expenses) since this will be a primary indicator of performance over the long term.

Note that each of these possible sets of funds includes 1)stocks in different size categories (large, mid, small), 2)international stocks (the US is not the only game in town anymore), and 3)funds of different volatilities (aggressive growth, growth and income). Adding a REIT funds adds further diversification by including real estate into the mix. The main point is to spread the assets out over a variety of kinds of stocks and investment strategies so that the performance of one portion of the portfolio can balance out that of the others.

Once the accounts are selected, start teaching your children these two of the three secrets to success in mutual fund investment - regular investment and rebalancing. (The third secret, diversification, is taken care of through the selection of the funds). Start off by buying some shares of one of the funds. Then, start buying additional shares once per month or some other period of time. If the child is earning an income, start having them set aside a portion of their income for investment - make it a regular part of their handling of finances. If they do not, if you've chosen to give your children some money to start out with, perhaps give a regular amount to them to invest.

As time progresses, buy shares in each of the five categories until the amounts are roughly equal. Then, start directing the monthly purchase to the mutual fund that has the lowest balance. This will be buying more shares of the fund that has performed the worst, thereby "buying low." Once a sizeable amount has been built up in each of the funds (such that your contributions are much smaller than the fund balances), you can also start rebalancing by selling shares of funds that have done very well and using the funds to buy more shares of the funds that have not performed as well. Note, however, that this will trigger capital gains, so it is better to achieve balance through the direction of contributions as much as possible.

Start out early and teach the principles of regular investment, diversification, and rebalancing, and your children will be on the way to a bright financial future.

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