Sometimes, we just can’t help it. We ask what if questions. What if, back in college, we had the guts to ask that person out? What if we had accepted that great job offer, located in another state?
What if questions rarely have answers—with one possible exception. What if you had started to invest from a younger age? We can’t turn back the clock. But if you inspire your child, your paperboy or the girl who mows your lawn to start investing now, it could change their lives. To get started, all they would need is $100.
Here’s how small, regular sums can grow. Imagine saving $3.33 per day, starting in 1977. At the end of each month, you put the proceeds (about $100 per month) into Vanguard’s S&P 500 index. By June 2015 it would have grown to more than $638,000.
Kids who start investing early can grow rich with ease. That’s Aiden Scott’s plan. The 14 year old, from Minneapolis, Minnesota has saved $412. “I made about $130 last summer,” he says, “when I bought a snow cone machine and sold snow-cones at the park by my house until I got kicked out.” Today, he takes a less exciting (and legal) approach to making money. He mows lawns and walks dogs.
I used to teach a high school personal finance class. When I showed kids how money compounds over time, many itched to start investing right away. About a third of my students opened investment accounts. Children, like Aiden, can open such accounts under their state’s Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). They’re called custodial accounts. There’s no limit to how much money they can invest each year. And the child gains legal control of the account once they’re no longer a minor. Depending on your state, that would occur between the ages of 18 and 21.
Aidan opened his custodial account with Schwab. There’s no annual fee and he could open the account with as little as a $100 initial investment. As long as Aidan sticks to Schwab’s low cost ETFs, he won’t have to pay trading commissions.
Schwab’s U.S. Broad Market ETF (SCHB) is made up of about 2,500 U.S. stocks. The average investor in actively managed funds pays about 1.3 percent per year in fees. Aidan will outperform most of these investors because his fees are much lower. His index fund costs just 0.04 percent. When investing, the less you pay in fees, the more you get to keep.
Sixteen year old Chase Schachenman was one of my students who opened a custodial account with Vanguard. You can see how he did it by following the online screencast that he created for my class. Chase invested in Vanguard’s Target Retirement 2060 fund. About 10 percent of the fund is made up of bond indexes. The remainder is invested in stock indexes. Chase pays a paltry 0.18 percent per year. The fund gets automatically rebalanced each year.
There’s just one problem with it. Investors need at least $1000 to invest in one of Vanguard’s target retirement funds. They need at least $3000 to buy one of Vanguard’s plain vanilla indexes, like the S&P 500. That’s a lot of money for a kid to raise.
Children can also open a custodial or guardian IRA with a company like Vanguard or Schwab. But they have to be earning an income during the year they make the contribution. Roth IRAs make more sense than Traditional IRAs because most kids don’t earn enough money to benefit from the up-front tax deduction associated with Traditional IRAs.
As tempting as it is, however, don’t dig into your wallet to fund your child’s investments. Our instincts tell us that we can help our kids by giving them money towards a home downpayment, a car, or an investment portfolio. But according to Thomas Stanley, the late author of The Millionaire Next Door, that likely does more harm than good.
Adults who receive financial help from their parents usually end up with far less money, compared to adults who don’t get handouts. Free money often gets wasted. Most fifteen year olds would demonstrate even less restraint than most adults.
To learn the value of money, kids need to earn it. It can’t simply spill from the bank of mom or dad. If this sounds too hard core, set up an agreement that’s like a 401K. You could match your child’s contributions, dollar for dollar, or 50 cents on every dollar.
You can change a child’s life if you empower them with money. They won’t have to ask that dreaded what if question. Albert Einstein once said that compound interest is more powerful than the splitting of the atom. That’s the kind of power that you want to give your kids.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.