|

Investing for Teenagers: Getting Started

ByWallstreet Observer

Quick answer

  • Start by opening a custodial brokerage account or Roth IRA with a parent’s help.
  • Focus on long-term growth with low-cost index funds or ETFs.
  • Understand that investing involves risk, and the market can go down.
  • Automate contributions, even small ones, to build a habit.
  • Learn about compound growth and how time is your biggest asset.
  • Consider your future goals to guide your investment strategy.

What to check first (before you invest)

Time Horizon

Your time horizon is the length of time you expect to keep your money invested before you need it. For teenagers, this is often very long, potentially decades until retirement. A longer time horizon generally allows for taking on more risk because there’s more time to recover from market downturns.

What to check: How long until you might need this money? Is it for college in 4 years, a down payment in 10 years, or retirement in 50+ years?

Risk Tolerance

Risk tolerance is your comfort level with the possibility of losing money in exchange for potentially higher returns. Younger investors with a long time horizon can typically afford to be more aggressive, as they have more time to ride out market volatility.

What to check: How would you feel if your investments lost 10%, 20%, or even more in a short period? Would you panic and sell, or stay invested?

Emergency Fund

Before investing, it’s crucial to have an emergency fund. This is money set aside for unexpected expenses like a car repair, medical bill, or job loss. Investing money you might need soon is risky, as you could be forced to sell during a market downturn.

What to check: Do you have 3-6 months of living expenses saved in an easily accessible account (like a savings account)?

Fees and Tax Impact

Investment accounts and funds come with fees, which can eat into your returns over time. Understanding these fees and the tax implications of your investments is essential. For teenagers, tax advantages can be significant.

What to check: What are the account fees? What are the expense ratios for any funds you’re considering? Are there any tax benefits to the account type you choose?

Account Type

For a 17-year-old, there are a few primary ways to invest. A custodial brokerage account is one where an adult (parent or guardian) manages the account for the minor until they reach the age of majority (usually 18 or 21). A Roth IRA is a retirement account that offers tax-free growth and withdrawals in retirement, and a parent can help open one.

What to check: Discuss with a parent or guardian which account type best suits your goals and current situation.

Step-by-step (simple workflow)

1. Discuss with a Parent or Guardian

  • What to do: Talk to your parents or legal guardian about your interest in investing. Explain why you want to start and what you hope to achieve.
  • What “good” looks like: Your parent or guardian is supportive and willing to help you open and manage an investment account. They understand your goals and the basic risks involved.
  • Common mistake: Not involving a parent or guardian, which is necessary for a minor to open an investment account.
  • How to avoid it: Ensure you have an open conversation and get their consent and active participation.

2. Set Clear Financial Goals

  • What to do: Define what you want your investments to achieve. Is it saving for college, a car, a down payment on a future home, or simply long-term wealth building for retirement?
  • What “good” looks like: You have specific, measurable goals with estimated timelines (e.g., “save $10,000 for a car in 5 years,” “build a retirement nest egg”).
  • Common mistake: Investing without a clear purpose, leading to aimless trading or emotional decisions.
  • How to avoid it: Write down your goals and refer to them regularly to stay focused.

3. Determine Your Time Horizon and Risk Tolerance

  • What to do: Based on your goals, figure out how long you can keep your money invested and how much volatility you can handle emotionally and financially.
  • What “good” looks like: You understand that longer time horizons allow for more risk, and you’re comfortable with potential market fluctuations for higher potential long-term gains.
  • Common mistake: Taking on too much risk for short-term goals or being too conservative for long-term goals.
  • How to avoid it: Be honest about your feelings regarding potential losses and align your investment choices with your timeline.

4. Build an Emergency Fund (If Needed)

  • What to do: If you don’t have one, set aside a portion of your savings for unexpected expenses.
  • What “good” looks like: You have 3-6 months of essential living expenses saved in a separate, easily accessible savings account.
  • Common mistake: Investing money that should be reserved for emergencies.
  • How to avoid it: Prioritize building this fund before making significant investments, especially for goals within the next few years.

5. Choose an Investment Account Type

  • What to do: With your parent’s help, select an account. Options include a custodial brokerage account (like a UGMA/UTMA) or a Roth IRA if you have earned income.
  • What “good” looks like: You’ve chosen an account that aligns with your goals and has low fees. A Roth IRA is often excellent for teens with earned income due to tax-free growth.
  • Common mistake: Choosing an account with high fees or one that doesn’t suit your investment timeline.
  • How to avoid it: Research different account types and consult with your parent/guardian and potentially a financial advisor.

6. Select an Investment Platform (Brokerage)

  • What to do: Open your chosen account with a reputable brokerage firm that allows minors (via a custodian) or offers Roth IRAs. Look for low minimums and user-friendly interfaces.
  • What “good” looks like: You’ve chosen a platform with low or no trading commissions, reasonable account fees, and tools to help you learn.
  • Common mistake: Picking a platform with hidden fees or a complex interface that makes investing intimidating.
  • How to avoid it: Compare several popular online brokers known for beginner-friendly options.

7. Fund Your Account

  • What to do: Transfer money from your savings or earnings into your new investment account.
  • What “good” looks like: You’ve made an initial deposit and set up a plan for regular contributions, even if they are small amounts.
  • Common mistake: Waiting to invest until you have a large sum, missing out on early growth.
  • How to avoid it: Start with what you can afford and commit to consistent contributions.

8. Choose Your Investments (Start Simple)

  • What to do: For beginners, consider low-cost index funds or Exchange Traded Funds (ETFs) that track broad market indexes like the S&P 500.
  • What “good” looks like: You’ve chosen diversified investments that align with your risk tolerance and time horizon, rather than trying to pick individual stocks.
  • Common mistake: Trying to “time the market” or invest in speculative assets without understanding them.
  • How to avoid it: Focus on long-term growth through diversified, low-cost funds.

9. Automate Your Contributions

  • What to do: Set up automatic transfers from your bank account to your investment account on a regular schedule (e.g., weekly or monthly).
  • What “good” looks like: Your investments grow consistently without you having to remember to make deposits each time.
  • Common mistake: Sporadic investing, where you only invest when you remember or have extra cash.
  • How to avoid it: Use the auto-invest features offered by most brokerage platforms.

10. Monitor and Rebalance (Periodically)

  • What to do: Check your investments periodically (e.g., quarterly or annually) to ensure they still align with your goals. Rebalancing means adjusting your holdings if they’ve drifted significantly from your target allocation.
  • What “good” looks like: Your portfolio remains aligned with your risk tolerance and goals, and you’re not making impulsive changes based on short-term market movements.
  • Common mistake: Constantly checking and reacting to daily market news, leading to emotional trading.
  • How to avoid it: Set a schedule for reviews and avoid making decisions based on fear or greed.

Risk and Diversification (plain language)

Investing inherently involves risk. This means there’s a chance you could lose some or all of the money you invest. However, understanding and managing risk is key to successful investing.

  • Diversification is key: Don’t put all your eggs in one basket. Spreading your money across different types of investments (stocks, bonds) and different companies or industries reduces your risk. If one investment performs poorly, others might do well, balancing out your overall returns.
  • Example: Instead of buying stock in just one tech company, invest in an ETF that holds stocks from many tech companies, or even an ETF that holds stocks from companies across various sectors (like technology, healthcare, energy, and consumer goods).
  • Stocks vs. Bonds: Stocks represent ownership in a company and generally offer higher growth potential but also higher risk. Bonds are loans to governments or corporations, typically offering lower returns but also lower risk.
  • Example: Buying shares of Apple (a stock) is generally riskier than buying a U.S. Treasury bond.
  • Market Volatility: The stock market goes up and down. This is normal. Prices can fluctuate daily based on economic news, company performance, or global events.
  • Example: During a recession, the stock market might drop significantly.
  • Long-Term Perspective: For young investors, the long game is crucial. Over many years, the stock market has historically trended upward, despite short-term dips.
  • Example: If you invested $1,000 in an S&P 500 index fund today, its value might be $800 next year, but it could be $3,000 in 20 years.
  • Compounding: This is when your investment earnings start earning their own earnings. It’s like a snowball effect, where your money grows faster over time.
  • Example: If you earn 10% on $100, you make $10. The next year, you earn 10% on $110, making $11. This difference might seem small initially but becomes significant over decades.
  • Index Funds & ETFs: These are baskets of many different investments, offering instant diversification. They are often low-cost and a great way for beginners to invest.
  • Example: An S&P 500 ETF holds stocks of the 500 largest U.S. companies.
  • Risk vs. Reward: Generally, investments with the potential for higher returns also come with higher risk. It’s about finding a balance that suits you.
  • Example: A startup company’s stock might offer a chance for huge gains but is also very likely to fail, making it a high-risk, high-reward investment.

During market drops, the best approach for a young investor with a long time horizon is often to stay calm and stick to their investment plan. Avoid selling in a panic, as this locks in losses. Consider it an opportunity to buy more shares at lower prices if you have extra funds.

Common mistakes (and what happens if you ignore them)

| Mistake | What it causes

Similar Posts