Are you teaching your children about investing? As they become aware of money and other financial concepts, it is smart to familiarize them with investing and arm them with know-how and tools they can take with them into adult life.

Children mature at different rates, of course, so it may be a while before they're ready to tackle concepts like portfolio creation and asset allocation. However, the basics of investing can be taught when kids are quite young.

Long before your kids start checking company profiles on the Internet, you can explain the relationship between risk and reward. To illustrate these concepts, let's sketch a brief picture of two common investments: stocks and debt securities.

Key Takeaways

  • Gradually familiarizing your child with how markets work will demystify the process of investing, making it feel more accessible to them when they're older.
  • Start by teaching them the basics of risk vs. reward, stocks and bonds, profits and losses.
  • Show them what stocks you own and explain why you chose to invest in those companies; have them join you in keeping an eye on the stock price and company news.
  • Once your child feels comfortable enough with the concepts, let them pick out a stock of a company they know or like; if you can afford to buy a few shares, then do so; if not, help them set up a model portfolio.
  • When your child is older, encourage them to invest money they've saved in a mix of stocks, bonds, and a savings account; you can help manage their portfolio, while still allowing them to take the lead.

Discuss Stocks and Bonds

Introduce the idea that, in contrast to the savings account your child may already have, stocks are a variable-risk, variable-return investment. On the whole, stocks are classified as high-risk—but along with that comes the potential for high returns. Explain that a stock's value can go up and down, depending on the growth and profitability of the company. But also make it clear that risk in stocks can't always be predicted—for instance, when corporate records are tampered with or CEOs lie. However, these events are outliers; overall, the stock market has risen consistently in the last hundred years, offering healthy returns.

A bond is a low-risk, low-return investment, or debt security. 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. 

Keep Your Child's Attention

If you own stocks, start by showing your child what you own. Interesting companies might get their attention—plane manufacturers like Boeing, sports gear specialists like Nike, technology companies like Apple; look at each company's investor relations page together to learn more about what the company makes, how much the company earned that year, and how many people work there. Then ask your child what company he or she would like to buy. Kids often have favorites even if they are not aware of them. Facebook and Disney, for example, 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 a few shares in the stock and then check the investment together at least once a week to show how it can rise or fall. Or, you can simply make a model online portfolio and track stocks for fun. 

If you pick stocks with your children when they are young, they'll experience how markets have up-and-down cycles; this will prepare them for the reality of market fluctuations and help them make informed decisions when they grow up.

Let Your Child Invest

When your child is older, you can provide a more in-depth explanation of stocks and other investments. Eventually, you want to let a child buy their own stocks. They may have enough cash diligently saved up in a savings account by the time they are interested in investing. Don't put it all into bonds 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 you can 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.

The Bottom Line

It's important to 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 that is learning that investments have advantages and disadvantages. Whatever the outcome, the experience of following their investments and gaining and losing money will be invaluable.