Finding stocks for kids to purchase is a worthwhile endeavor, but if you’re like me it doesn’t end there. While I’m absolutely interested in build a stock portfolio for my kids that can earn money and that they can take over eventually, I’m also quite interested in ensuring my kids learn how to invest themselves. And in many ways, teaching your kids about stocks takes much more of your time and energy, but if done well and thoughtfully, it can pay dividends for a lifetime!
In this article on stocks for kids, we’re going to do both. We’re going to discuss picking some stocks to build a portfolio for your kids, but we’re also going to spend some time walking through how to teach your kids about investing. I’ll explain some of the things I’ve done already with my kids and what I’ve found that has worked well and what hasn’t. Hopefully you can learn from my experiences and make great progress in teaching your kids about the stock market and investing in general.
Table of contents:
- Stocks to buy for your kids portfolio
- The funds approach
- The individual stocks approach
- Teach your kids how to invest
- Understanding the stock market
- Understanding compounding & investment returns
- Learn about specific companies and buy some stocks
- Understanding funds and ETFs
- Investment account options for kids
Stocks for kids: Setting up a portfolio for your children
If your goal is to set up an investment account, build a portfolio, contribute some funds either now or on an ongoing basis and eventually pass the portfolio on to your kids, then that’s great! Choosing the right investments for the account is obviously important. There are primarily two ways you might go about doing this depending on some of your goals.
If your goal is simple to build value and growth over time and the learning component of the portfolio isn’t a priority, you might consider just going with a few index funds and not being overly concerned with individual stocks.
If your goal is to build value and growth but also pull your kids into the process and have them learn about investing along the way, then individual stocks (you could still allocate some of the portfolio to funds as needed) might be a better tool to interest your kids and keep them engaged. Keep reading to read why individual stocks are a great learning tool.
A portfolio of funds
Let’s look at specific investments for each of the above two scenarios we’ve outlined here. First, we’ll examine the funds approach. As we outlined in the best investments for kids article, we mentioned the classic three-fund portfolio approach:
The three-fund portfolio essentially aims to provide broad, diversified exposure to US stocks, US bonds and international stocks. You can get super low-cost ETFs and accomplish a very diversified portfolio that performs very well historically by just buying three simple ETF funds. Here are examples at the three large brokerages:
- Schwab: Total Stock Market (SCHB), International (SCHF), Bond Index (SCHZ)
- Fidelity: Total Stock Market (FZROX), International (FZILX), Bond Index (FXNAX)
- Vanguard: Total Stock Market (VTI), International (VXUS), Bond Index (BND)
When building the three-fund portfolio, you need to decide what you want your equities/bonds split to be. Since this investment account is for your kids, and they have many decades of investing ahead of them, a higher equities allocation probably makes sense (at least 80%). If you go with an 80/20 equities/bonds split, then you also need to determine what your split between domestic and international exposure should be within the equities bucket. You’ll often hear of investors doing somewhere in the range of 20-30% of the equity exposure to be allocated to international. So in an 80/20 portfolio, 20-30% of the 80% in equities would be allocated to international equities. There’s a really nice breakdown of performance of the three-fund portfolio approach over at Bogleheads.
The following image shows what the various equities/bonds split portfolios returned each year between 1997 and 2019 using the Vanguard funds. It also assumes a 30% international allocation within the equities bucket.
The next chart shows the average annual returns (compounded) using these same portfolios:
The above information is really useful for mapping out a simple three-fund portfolio for your kids (or for anyone really). Again, since your kids have many years ahead of them, it makes sense to probably consider the heavier equities allocations (80/20 in the above example). You might go even more aggressive with a 90% equities allocation. Either way, the above information can give you some sense of how these portfolios perform over time through bear and bull markets.
A portfolio of individual stocks for kids
Like we said above, if your goal is to educate while growing the portfolio value, individual stocks can be useful in gaining the attention of kids. The reason for this is kids will likely be more intrigued at the idea of owning the company that makes the iPhone or the company that delivers packages every week to your door than, a basket of stocks in a fund, which is essentially just a financial instrument. No matter how excited you attempt to make the idea of investing in an index fund, it’s just not going to gain as much interest from your children in most situations.
So, what kind of stocks should you put in a portfolio for your kids? You have two goals: make money and make it interesting. Thankfully, you don’t have to really choose between the two. What I would suggest is potentially coming up with a list of quality stocks yourself first, then letting your kids choose some from that list. Then after they’ve made their choices, maybe explain that you’re going to choose a handful of stocks for them. And the combination will be the portfolio.
Let’s consider how we might identify a list of contenders to be included in the portfolio. First, we want to make sure we’re thinking long-term. Second, we should consider companies that are thriving in the current and future environment rather than the past environment. For example, think Amazon rather than Macy’s. Next, consider some stocks of companies that are present in every day life so that your kids can have a connection to the stock. The obvious contenders here for many kids (including mine) are tech stocks like Apple, Amazon, Netflix and Tesla. But remember you don’t just want all tech stocks. If your kids start rattling off nothing but tech names, use it as an opportunity to discuss diversification.
Now, if your kids only know a few companies, you could always do a blend of approach #1 and approach #2. Invest in the stocks they like, and supplement it with a good S&P index fund in order to ensure long-term diversification. The index fund could be mommy or daddy’s contribution to the portfolio.
Here are some individual stocks you might consider, categorized in ways that can be helpful for discussions with children:
Entertainment / Media:
- Netflix (NFLX)
- Disney (DIS)
Grocery / Food / Logistics:
- Walmart (WMT)
- Amazon (AMZN)
- Target (TGT)
- McDonalds (MCD)
- Coca-Cola (KO)
- Apple (AAPL)
- Microsoft (MSFT)
- Tesla (TSLA)
Health care and medicine:
- Pfizer (PFE)
- Johnson and Johnson (JNJ)
- Home Depot (HD)
- Nike (NKE)
Banks & Credit Cards:
- Bank of America (BAC)
- American Express (AXP)
- Visa (V)
Teaching your kids about the stock market
If your goal is to teach your kids how to invest rather than just find stocks for kids, then let’s identify a possible framework for how to approach the subject for your kids.
Understanding the stock market
If your kids are going to learn how to invest, they need to understand the stock market generally. Here are a few key concepts you can talk through with your children:
What are shares actually?
When you buy stocks for kids, or if your kids buy stocks, you’re buying shares of a company. But what are shares exactly? Well, a share is a piece of ownership of the company. When you own a share, you own part of the company! Yes, you can own part of Apple, or Netflix or your other favorite public company.
When I talked this through with my kids, they were intrigued but were initially very confused about just how large these companies were and how little a single share really represented of the company. For example, they often asked me questions such as, “Well if I had a million bucks, could I buy all of the shares of Netflix?” Nope, not even close! Depending on your kids level of understanding, you might get into the concept of market cap and outstanding shares. If a company has a market cap of $100 billion and shares are trading at $100 each, then how many outstanding shares are there? The answer of course is $100 billion / $100 which equals 1 billion. There would be a billion outstanding shares. So if you own a single share, you own 1 billionth of the company (roughly speaking).
What’s the difference between public and private companies?
As I talked through some of these initial concepts with my kids, they’d ask things like, “Well can I buy stock in <insert some company>?” Some of the companies mentioned were not publicly traded companies, so the answer would be no. We had to talk about the differences of public and private companies. A public company is a company that has some of its equity or ownership owned by the public through shares that trade on the stock market. Private companies are companies of which individuals in the public cannot own pieces.
Why do companies go public?
Why don’t all companies just stay private? There are many reasons, but the main reason is that companies go public in order to raise money. A company can essentially sell part of itself to the public stock market in exchange for cash to use to grow the business. That chunk of the company that got sold to the public then trades on the stock market. Companies can raise money for growth via private markets or public markets. They can also raise money via debt and equity offerings. When companies raise money via equity (ownership) using the public markets, it is often referred to as “going public.” As a result of “going public,” the public can now buy and sell shares of the company.
The stock market is a market
Because the stock market is just that, a market, it means that shares of companies are bought and sold on a regular basis. In fact, large companies such as Apple can have its shares trade hands millions of times on a daily basis (this is called volume). It’s important that a liquid market exists for large businesses because it means two things: 1) if you hold the stock you can exit the stock any day that the market is open and 2) because the shares are trading hands so often (this is called liquidity), you can have a good idea of what the stock is worth at any given time (whereas illiquid investments can be tough to value at any given moment).
Understanding compounding and investment returns
The next thing your kids need to understand as we buy stocks for kids is the idea of returns. Returns simply speaking refer to making money on your investments! In other words, the entire reason for investing!
When teaching our kids, we want to accomplish two things with respect to understanding returns. First, we want them to understand the power of compounding returns in a conceptual way. Second, we want them to be able to be able to compute various forms of returns. Let’s start with the concept of compounding returns.
Concept: The power of compounding returns
The power of compounding interest or compounding returns is most evident when looking at the end result of investing over time. And the power of compounding is shown most clearly by comparing a few examples of starting saving or investing at an early age versus a later age. For instance:
What can we takeaway and what can we make sure our kids understand? It’s simple. The earlier you start, the more money later. In fact, the difference is so great that by starting ten years earlier, the difference is more than double in our example above. If kids start investing at crazy early ages, say even as a teenager, it’s just insane how much wealth they could accumulate!
Also, gains get really big in the later years of this scenario, so the more “later years” you give yourself by both starting early and regularly investing during each interval, the differences can get just incredible. Let’s try to drive this point home one more time.
Similar to our graphical example above, let’s assume 8% annual returns and monthly savings/investments of $250 per month. Remember how we said the more “later years” the more impactful? Let’s try to demonstrate this…
- Year 10 to Year 11, the balance goes from about $46,000 to $53,000 for a change of $7,000.
- Year 20 to Year 21, the balance goes from about $148,000 to $163,000 for a change of $15,000.
- Year 30 to Year 31, the balance goes from about $375,000 to $409,000 for a change of $34,000.
- Year 40 to Year 41, the balance goes from about $878,000 to $954,000 for a change of $76,000.
…and it keeps going. As you can see the annual jumps in your wealth are much, much bigger in the later years of this scenario than the early years. After 40 years of this, your wealth is increasing more than $75,000 every single while only saving of investing $3,000 each year at that point. So, you need to get to these later years where your money REALLY starts to grow. This is the power of compounding.
Cumulative returns and annual returns
The next part in teaching stocks for kids involves doing a bit of math. For my kids, they were able to understand cumulative return and how to compute it pretty well, but found annual return a bit harder to compute (the exponent use adds some difficulty). For your kids to be able to do this kind of math, they should be comfortable with order of operations.
Cumulative return can also be called total return. Cumulative return is independent of how much time has elapsed. It simply measures how much money you made on an investment regardless of how long you held it. As you’ll see, annualized return addresses the time period issue. So how do we calculate cumulative return?
cumulative return = ( ( ending value – starting value ) / starting value ) x 100%
Let’s look at a quick example. If you invest $1,000 in a stock, then sell the stock for $1,750 a couple years later, what is the cumulative return? Using our formula, we would do the following:
cumulative return = ( ( $1,750 – $1,000 ) / $1,000 ) x 100% = ($750 / $1,000) x 100% = .75 x 100% = 75%
Now, what if we want to know what our return was annually? In investing, most people want to know what a potential investment will return each year while holding it on an ongoing basis. This is called annual or annualized returns. This equation is slightly more complicated than the cumulative return formula.
annual return = ( ( ending value – starting value ) ^ (1 / years) ) – 1 (then multiple by 100%)
So, let’s look at another example. Above we mentioned an investment that we bought for $1,000 and sold for $1,750. What if we held that investment for 5 years? What’s the annualized return?
annual return = ( ( $1,750 / $1,000 ) ^ (1 / 5) ) – 1 = ( 1.75 ^ .2 ) – 1 = 1.118 – 1 = .118 x 100% = 11.8%
The annual return in this situation is 11.8%.
If you feel your kids have grasped these concepts, here are some practice questions:
- You invest $1000 into a company’s stock. 7 years later, you sell the position for $1800. What is the cumulative return and what is the annual return of the investment?
- You purchased 50 shares of a stock at $1000 each 5 years ago. You just sold the 50 shares today, but now they are $1400 each. What is the total return and the annual return?
- Challenge question: You want to invest $10,000 today and you want to sell the position in 5 years for double what you put in, what annual return will be required in order to achieve this?
Learn about specific companies and buy some stocks
Ok, we’ve learned some concepts and now it’s time to get into some specific stocks for kids. It’s really hard to get kids to be motivated and continue learning about stocks if they do not eventually own some stocks themselves. Personally, I saw my kids come alive once they had their own accounts where they could check their stocks and their balances.
I allowed my kids to pick three stocks each, and I told them that one of the three had to be a non-tech stock (kids are going to be mostly familiar with the various tech stocks). But how can you make sure that your kids are learning about these companies and not just buying the stocks with the heart and mind of someone playing blackjack? I used some simple assignments both in the beginning and on an ongoing basis to engage the kids with these companies. For instance, I asked a few questions and required my kids to write a few sentences for each of these. What company do you want to invest in? What is the ticker symbol for the company? How does the company make money? Why do you think the company will make even more money in the future (and thus make it a good investment)?
On a later assignment, I had my kids write a simple essay on the history of one of the companies in which they invested.
And of course owning the stocks themselves is fun. The kids love checking their stocks. It leads them to ask good questions about why it might be up one day and down the next. Having their own stocks really makes everything come alive.
Understanding funds and ETFs
After getting a good grasp on stocks for kids, it can be a good idea to introduce funds and ETFs. The point of course of funds and ETFs is diversification. Helping your kids understand the value of diversification and reducing single stock/company risk can be worthwhile and point them towards the value of funds. The simplest way to map out what funds and ETFs are is that they are baskets of stocks. It’s a way to hold a large number of stocks all at once through a single investment. Funds and ETFs do have shares and share prices just like single stocks.
Investment account options for your kids
So you have identified some stocks for kids, but you need to know where to put these stocks. You need an account from which to make investments. For kids, there are a number of options. Here we will provide an overview of the popular options, but you can always call up customer support at the large brokerages to find the best option for you.
529 Savings Account
A 529 account is one of the most common account types that parents open for their kids. The primary purpose of these accounts is to save for college and other education expenses. The advantage, of course, is that there are tax benefits in which the gains from your investments are tax free as long as they are used for qualified educational expenses. 529 accounts are also extremely flexible since you can change the beneficiary on the accounts to another child in the situation where your child doesn’t need all the money for his or her education.
While most people don’t consider IRA accounts for kids, if you’re able to pull it off, what an incredible benefit you can give to your kids. The primary restriction around IRA accounts are around earning an income. To have money contributed to your own IRA account, the person has to have earned income (or taxable income). The person needs to be filing a W-2 essentially. So, if your kid has a job and is paying taxes on the income, you can contribute money into an IRA in this child’s name (note that in this scenario you can be the one to contribute the money as the parent). Since the taxes your child is likely paying is pretty minimal, starting a Roth IRA in your child’s name would be massively beneficial to his or her future. To begin the compounding process we described above at such a young age could result in massive sums being compounding over many years. Be sure to talk to a tax professional about the potential eligibility of your child being able to participate in an IRA account.
When talking stocks for kids, the custodial account is the most common account type being considered. A custodial account is essentially a brokerage account in your child’s name that is classified as a custodial account. A custodial account means that the parent is in control of it, but the assets are legally owned by the child and these assets will be turned over at a particular age to the child (usually 18 or 21).
Most brokerages such as Charles Schwab or Fidelity offer custodial accounts and they are easy to setup. There is one situation, however, I was unable to find through the major brokerages and that was a custodial account that allowed me (or my kids) to purchase fractional shares. Note that Schwab has announced support for fractional shares, but so far have not rolled out this feature to customers (as of May 2020). This is likely in response to the popularity of Robinhood which offers incredible ability fo individuals to invest in stocks at zero commissions and with low balances. Note that Robinhood as of writing does not offer custodial accounts.
Why do I want fractional shares? Well, my kids might want to regularly invest in a stock like Amazon (AMZN) which trades at over $2,000 per share, and we aren’t planning on contribution over $2,000 weekly or monthly. Rather, my kids are going to be investing $5 per week or so, and it’d be really nice to still be able to invest in stocks that have share prices much higher than this contribution level. The solution I found for this is called Loved Investing. With the Loved app, I was able to setup my kids custodial accounts and setup weekly contributions into a few stocks for each kid. I can manage all three of the custodial accounts on the same app which makes it very simple for me and easy for my kids to see balance updates. Loved offers fractional shares and charges zero commissions. Perfect.