Is the stock market for kids? Yes! Sure, it’s unlikely that your kids are going to be managing money and trading actual stocks (at least at a young age), the stock market can be an incredible tool for teaching your kids about math, finance, personal finance and investing. If your kids are older, you can even touch on subjects such as psychology and economics.
For quick reference, you can jump to specific sections regarding various ages groups and what might be an appropriate depth of study regarding the stock market for kids:
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As a parent, I’m extremely interested in finding ways to teach my kids about a wide variety of subjects. I really like the stock market because it ties together a number of math concepts with a very real and important mechanism in our economy. Moreover, kids will be naturally intrigued (and incentivized) by the idea that they can make money! Of course, it will be fake money as they won’t actually be in stocks, but some parents might consider a $10 reward if their stock market portfolio hits a certain level of performance. Our goal isn’t to get our kids to find some winning stock portfolio. Our goal is to get them to be engaged so that they learn. Sometimes a simple $10 reward after a period of time is useful for encouraging engagement.
I’ve found that kids are often drawn to learning about the stock market for a variety of reasons. First, the transactional nature of the stock market is exciting. After learning how you can sell a financial instrument for profit, many kids will often remark, “You mean I can make money without doing chores?”
Second, you can focus on stocks of companies that your kids are already quite familiar. Nearly every kid gets exposure to ipads and iphones at an early age, and kids in today’s world are typically quite familiar with those Amazon packages that come each week. Or, consider the Ford car in the driveway. Or, buying groceries at Walmart or lunch at McDonald’s. Your kids are more familiar with some of the world’s most traded stocks than you likely realize, and your kids will enjoy learning about how the stock that trades in the stock market intersects with the companies they interact with in everyday life.
Third, the stock market is a living and dynamic world, and provides a rich method for exploring math topics that kids might otherwise find mundane. Practice problems on worksheets are useful of course, but watch your kids actually enjoy some math when they are calculating how much money they may have gained in their model portfolio!
So, depending on the age, I think there are some key learning goals. Let’s look at them briefly. Note that these age ranges are just a guideline. Some kids are ready for more advanced topics and are mature enough to focus on hard subjects at an earlier age. Other kids need more time before they’re ready for harder topics. You know your kid best, so adjust accordingly.
Stock market for kids between ages 7-10
For kids in this age range, the goals are to introduce the overall concept of the stock market and the transactional nature of it. For instance, children in this age group need to learn that you can take money and exchange it for a particular stock (a BUY transaction). At this point, you now own the stock. You can also sell a stock and exchange it for money (a SELL transaction).
Learning to record transactions and tracking value
To learn this, your child can keep his own ledger that records transactions. Perhaps start with an imaginary $1,000 (this is your first entry on the ledger). Then, allow your child to use some of that money to purchase stock. Stick to a company your child is familiar with (Apple is everybody’s favorite it seems). The goal here is for your child to learn how to log transactions and to simply understand that when you buy a stock that you are exchanging money for the stock that you own.
The next piece of this is to understand that the value fluctuates even when you aren’t making transactions. So, take your ledger that your child has been building, and consider creating a new document that tracks the overall value of the portfolio perhaps once per week or once per month. Each week or month, your child will need to look up the stock price of his or her holdings, calculate the value of each holding, add it up with the cash and tally the current value of the overall portfolio. This part is very key to your child understanding the basics of investing and the basics of the stock market. Can your child understand how the value of his or per portfolio is moving up and down as the stocks trade on the market?
Understanding this takes consistently doing the following two things: First, your kid logging the values each week. Practice makes perfect. Doing this repeatedly over time really will solidify the concept. Secondly, ask your child questions such as, “Why did your portfolio change values even though you had no transactions?” and “Can you explain what a transaction means?”
The following image shows what your child’s ledger might look like. This ledger both logs transactions and values the portfolio once per month given no transactions. As you can see, we track the cash value, the stock value, and the two of these add up to overall portfolio value.
Percentage change & Cumulative return
What about math concepts? Remember a big part of why teaching the stock market for kids is a great idea is because of the math concepts it teaches. For kids in this age group, two math concepts that are perfect to teach and practice are percentage allocation and percent increase and decrease.
As you child does his or her fake transactions, have them calculate the percentage of the portfolio that each position holds (including cash). As the overall portfolio value moves up and down, they can re-calculate the percentages for additional practice. As they’ll see, each position can become more or less of the overall portfolio as individual positions move up and down in value. Ask them questions regarding this to ensure they understand how a position can now make up more of a portfolio even though they did not buy any more stock of that company.
Additionally, as your child tallies the portfolio value for each period of time, it’s time to add in the percentage increase or decrease. You can do this a few different ways. If this is a relatively new project, just stick to calculating the percentage increase or decrease since inception of the portfolio (from the initial value of $1,000). For example, if the portfolio has a value of $1,150, you would calculate the percentage increase by calculating 1,150 / 1,000 – 1 = .15. Then, help your child understand that .15 equates to 15%. Similarly, if the portfolio value is down, say $900, you can calculate the percentage decrease by calculating 900 / 1,000 – 1 = -.1. This equates to -10%.
Note that in financial terms, this equation is commonly referred to as the cumulative return. When considering the percentage increase, or percentage gain, from the beginning of the portfolio to the current date, you’re determining the cumulative return of the portfolio. Cumulative return is a key term for your kids to learn. With this in mind, let’s generalize our previous calculation, and make note of this important formula for calculating cumulative return:
cumulative return = (ending value / beginning value – 1) x 100%
One quick example to demonstrate the use of this formula. If our portfolio has a starting value of $50,000 and now has a value of $83,000, we can determine the cumulative return by first determine 83,000 / 50,000, which equals 1.66. Then, we subtract 1, which gives us .66. Next we do .66 x 100% to get 66%. Our cumulative return is 66%.
Note that cumulative return doesn’t tell us anything about the span of time in which this return was gained (or lost). Cumulative return is just the return from beginning to end, regardless of the time span. We’ll get into return rates for specific periods of time in the next section.
Stock market for kids between ages 11-14
To consider this stage, your child should already be familiar and extremely comfortable with the concepts discussed in the ages 7-10 range. Again, the specific ages aren’t overly important. For this age group, we will expand upon the previously discussed areas and introduce a few more complex concepts to teach and introduce.
Learning About “The Market”
At this time, we’d like to introduce young stock market students to the idea of stock market indices and benchmarks, namely the S&P 500 and the Dow Jones. Kids need to learn that often times when people say “How’s the market doing?” they are referring to the performance of either the S&P 500 or the Dow Jones. So what are they?
The S&P 500 makes up, generally, the 500 largest companies in the U.S. stock market. The Dow Jones makes up a broad selection of 30 largest U.S. companies. Both the S&P 500 and the Dow Jones index are intended to give investors an easy way to see how the major U.S. companies are doing at any given time. Do they perfectly represent the U.S. economy and stock market? No, but they’re decently representative, and more importantly, traders and investors cite them daily as indicators for stock market performance.
The next step for kids who are already comfortable tracking their portfolio performance across time is to begin comparing this performance against the Dow and S&P index values. This will serve to accomplish a couple things. First, your children will get continued practice in regular tracking of the stock market. Second, they will get practice comparing performance across assets or indices.
Conceptually, the most important thing to teach here is that how your portfolio performs compared to the market (we’ll assume this means the S&P 500) is extremely important. Rarely do we cite raw performance of a stock market portfolio (“My portfolio is up 8%.”). Raw performance without comparison against the market doesn’t tell us as much. Instead, it’s important to be able to say “My portfolio is beating the S&P 500 by 3%.”
Rate of return for specific periods of time
Previously we discussed cumulative return. Next, we need to look at the rate of return for more defined periods of time. For instance, year-to-date return (YTD) is a very common number cited in investing. Investors will often want to know, “What is the S&P up year-to-date?” Well, calculating this is easy if you already know how to do cumulative return. We essentially just adjust our start date for the equation.
YTD return = (today’s value / Jan. 1 value – 1) x 100%
Let’s look at a quick example. If the S&P 500 is currently trading at 2,650, and the S&P 500 opened the year at 2,323, what is the YTD return of the S&P?
YTD return = (today’s value / Jan 1 value – 1) x 100%
today’s value / Jan 1 value = 2,650 / 2,323 = 1.141
1.141 – 1 = .141
.141 x 100% = 14.1%
We can say that the S&P 500 is up 14.1% year-to-date
Ok, now that we’ve addressed market indices and year-to-date return, it’s time for your child to build upon his or her tracking document or spreadsheet that we discussed in the previous section. Along with tracking portfolio performance at regular intervals, we should now add a column for tracking the S&P 500 performance. Each time we log the value of our portfolio, now we can log the current value of the S&P 500. Next, add a column for cumulative return for your portfolio and a column for cumulative return for “the market.” If your child desires, add a third column that compares the performance for his or her portfolio vs. the market performance.
The below image shows an example updated ledger with columns for cumulative return, S&P 500 performance, and S&P 500 return. Note: We used SPY instead of the raw S&P 500 values. SPY is an ETC that tracks the performance of the S&P 500, so for this type of situation, SPY is sufficient.
Introducing diversification
One of the most important concepts in investing, and certainly one of the most discussed, is the concept of diversification. Our interest here isn’t to have our kids master all of these concepts, but to introduce them enough to where they can understand the basic concept and begin the process of thinking how these concepts might be applied.
To introduce diversification, first ask your child a series of questions about the stock or handful of stocks they have been tracking. In our examples above, we’ve been tracking Apple (AAPL). So, we might ask our child, “What happens if Apple has problems, and AAPL goes down significantly?” Additionally, “Would having all your money in a single company make your nervous?” Then, finally, “Can you think of a better approach that might make you less nervous?”
Of course this line of questioning is aimed to get our children to think about the risk of having all your eggs in one basket. Helping them come to the conclusion that spreading their money around a bit might be less risky is our goal. Some kids will immediately get it, others might need some help getting to this point.
You can further drive this point home by discussing the idea that while one company can fail, it’s much less likely that a group of 10 or 20 or even 100 companies will all fail at the same time. Therefore, if we’re invested in a larger group of companies, if one fails, we’ll still be ok. If we’re invested in one company, and that one fails, we’d potentially lose all our money.
If you want to take the discussion even further, you can introduce the idea of different sectors. For instance, if you own Apple stock, ask your child if you’d be more diversified if your second stock was another technology stock like Microsoft, or if your second stock was a company like Walmart (WMT)? You can discuss with your child how sometimes there could be problems with specific sectors and it can be useful to diversify across multiple sectors to truly reduce your risk.
In the previous sector, we introduced the idea of having our kids calculate allocation percentages of a portfolio. You can re-visit the allocation percentage discussion with regards to diversification. If you have, say, 5 positions spanning allocation percentages anywhere from 10-25%, ask your child to group these allocations by sector. Is any one sector too “over-weight” (too much allocation to one sector, preventing proper diversification)?
Introducing dollar cost averaging
Moving along to further instruction, we want to get into the topic of dollar cost averaging, But before we do that, we need to take a step back and talk about the idea of investing over time. Until now, we’ve invested with the idea of having a chunk of money, then investing it over time. We never put more money into the equation.
The biggest thing we can do with our kids is teach them the value of saving money and investing that money regularly. If you’re reading about the stock market for kids, then undoubtedly, you’ve talked to your kids about saving money as well. Extend that conversation further. If you’re saving regularly, what are you doing with that money? Part of it should be invested regularly as well.
The beautiful thing about investing over time is that you benefit when stocks go up or down. When they go up, your portfolio gains in value. When they go down, your regular contributions get to buy more shares at lower prices. This is the idea of dollar cost averaging. To solidify the concept, I encourage you to work through a few examples. For instance, if you want to buy five shares of Apple over four months, the purchase price might be something like the following: 1 share at $150, 2 shares at $175, 1 share at $180, 1 share at $200. What is the average purchase price of the shares?
( (1 x $150) + (2 x $175) + (1 x $180) + (1 x $200) ) / 5 = $176
The average purchase price of the five shares was $176, or the 5 shares cost $880 total.
If you want to do a more complicated, real world example, find a stock that is under $100. For instance, as of writing, Target (TGT) is trading at about $62 per share. Make up some price fluctuations such as $68, $72, $58, etc. Have your child work out the following. If you invest $100 each month and use it to buy Target stock each month, how many shares do you end up with after one year? What is the average cost per share? This kind of exercise will help solidify the concept of dollar cost averaging for your kids.
Stock market for kids between ages 15-18+
For this age group when discussing the stock market for kids, it is time to introduce some of the fundamentals around stocks as well as other important considerations for investing such as dividends, splits, and more.
Most of what we’ve covered in this stock market for kids guide has centered around the actual transactions of buying and selling stocks, how you can gain or lose money and what investing over time means. Now we’re going to discuss more advanced topics and introduce some factors for how to select stocks.
The first fundamental to learn: The P/E Ratio
Before we get into specifics about fundamentals, let’s talk about them at a higher level. It’s important that your child understands that each stock represents a company. That company is a real company or business with employees, products and services, brands and more. Companies have revenue and costs. When you consider the revenue brought it by selling something, and subtract the costs associated with producing and selling it and running the business, the business has profits. When it comes to investing (and accounting), we typically refer to the business profits as earnings. Earnings are very important in investing.
In investing, we also consider important metrics such as a business’s earnings on a per share basis. So, rather than saying that Company ABC earned $2 billion, we often say that Company ABC earned $4 per share. If you know the number of outstanding shares of the company, you can easily go back and forth between total earnings and earnings per share as follows:
earnings per share (EPS) = total earnings / outstanding shares
total earnings = EPS * outstanding shares
A quick example: If Company ABC earning $2 billion, and they have 400 million outstanding shares, what was the earnings per share (EPS)? We know that EPS = $2,000,000,000 / 400,000,000. EPS = $5.
The P/E ratio stands for the price to earnings ratio. What this does is give us, at a glance, a quick way of determining how expensive a stock might currently be. It does this by telling you what kind of multiple you are paying for the company’s earnings. If Company ABC is earning $5 per share, and its stock is currently trading at or priced at $40, it means that to buy the stock, you have to pay 8 times its earnings to own the stock. Its P/E ratio is 8. You can calculate the P/E ratio as follows:
P/E ratio = Stock price / Earnings per share (EPS)
A quick example to solidify the concept: Company DEF is earning $4 per share and currently trades at $85. What is its P/E ratio? We divide $85 by $4 to get the P/E ratio. 85 / 4 = 21.25.
Now, if Company ABC has a P/E of 8 and Company DEF has a P/E of 21.25, ask your child which company is more expensive? The correct answer of course is Company DEF. Ask probing questions to ensure they understand the concept of a multiple. The multiple of earnings that a company is valued at is an extremely important overall concept to understand in business and in investing.
Lastly, if you child grasps the P/E ratio quickly, you can explore more thoughtful questions with him or her. Ask your child why might some stocks trade at higher P/E ratios than others? Why would someone be willing to pay a high multiple for some companies than other companies? Most kids, if investing is new to them, will struggle to find correct answers to this question. Some possible answers to discuss are growth rates, sector or industry and public relations. For instance, if a company is growing revenues at 50% versus a company that is growing revenues at 5%, the higher growth company will command a higher multiple. Additionally, some sectors or industries are considered to be declining sectors versus some industries are considered up and coming sectors. For example, a company that manufactures railroad parts will likely have a lower multiple than a company manufacturing electric car parts. Lastly, multiples can be depressed if a company goes through a series of bad publicity. When Chipotle (CMG) got hit with a series of headlines about how people got sick eating at their restaurants, the stock and the multiple went down dramatically.
Dividends, Market Cap & Stock Splits
So far, we’ve only discussed making money by buying a stock, seeing its price rise, then selling it for a gain. There are other ways, however, you can earn a return on your investment. The main way most investors focus on is the dividend.
At its basic level, a dividend is a payment from the company to its shareholders. When a company accumulates earnings, it can take a part of those earnings and distribute them to shareholders as a reward for owning the stock.
Let’s go back to our Company ABC example that was earning $5 per share. EPS can often be a quarterly figure, but for simplicity, we’ll assume that it earns $5 per share per year. As a reward for owning the company, ABC also pays a $2 dividend per year. Dividends are typically paid on a quarterly basis, so that $2 dividend will be four $.50 payments per share that you own every 3 months. If you own 100 shares of ABC, you’ll get $50 every quarter which will total to $200 per year.
Considering dividends is a very important part of calculating the total return of the stock. So, let’s look at a complete transaction to understand total return. Let’s say that on Jan. 1, 2018, you purchased 100 shares of ABC at $35 each. You sell the 100 shares on Jan. 1, 2019 at a price of $42. You also collected 4 quarterly dividend payments at $.50 per share. What is the total return of the stock?
Total return = Price appreciation + dividends collected
Price appreciation = (number of shares x sell price) – (number of shares x buy price)
Price appreciation = (100 x $42) – (100 x $35)
Price appreciation = $4200 – $3700
Price appreciation = $500
Dividends collected = Number of payments x number of shares x quarterly dividend
Dividends collect = 4 x 100 x $.50
Dividends collected = $200
Total return = $500 + $200 = $700
Conceptually, it’s important for new investors to learn that dividend payments help earn a return on your investment even without selling the shares themselves. In fact, some investors might hold a particular company for decades without ever considering selling and just collect the dividends year after year.
Stock splits are the other important element that kids should become familiar with. Over time, a company may decide to issue a stock split and reduce the trading price of each unit of stock. For instance, a company that is trading at $500 per share might decide to do a stock split where they double the number of outstanding shares, but now all shares are trading at $250 instead of $500. The key element to understand here is that fundamentally, nothing changes with the value of the company. The market cap doesn’t change. Market capitalization, or market cap, refers to the total value of the company (as evidenced by the value the stock market assigns to it). We can calculate it as follows:
Market Cap = Share price * Number of outstanding shares
If a company has 500 million outstanding shares and trades at $100 per share, we know that the company has a market cap of $50 billion. If the company issues a 2-for-1 stock split, the result would be 1 billion outstanding shares that now trade at $50 per share. The market cap is still $50 billion.
Beginner investors sometimes are confused into thinking that they’re winning by the company issuing a stock split. In truth, nothing has really changed. The company still has the same value even if the share price changed.
Bonus Advanced Topics
If you’ve surpassed the wide range of topics in this stock market for kids guide, then here are some additional advanced topics you might consider.
Risk adjusted returns
Introducing the topic of risk and risk adjusted returns is a key element to understand for savvy investors. This is a major topic, but teaching your child how to calculate daily returns, how these daily returns can be used to calculate volatility and how volatility can impact the notion of risk adjusted returns is a powerful concept to understand. To perfect this, you might want to research and understand how to calculate daily returns, standard deviation and the Sharpe ratio.
Technical indicators
Technical indicators are used to describe the action and movement of a particular stock. They are often utilized in conjunction with charts that show how a stock has moved up and down over a period of time.
The best indicators to start with are moving averages. Understanding how a moving average essentially “smoothes” out the price action of a stock (and increasingly smoothes out the price action as longer time periods are used) is an important consideration. Additionally, when two moving averages of varying durations intersect or cross, it can be interpreted as important signals (e.g. when a 50 day moving averages crosses below a 200 day moving average, many consider this to be a bearish signal).