Apps like Acorns (acorns.com) and Stash (stashinvest.com) make it possible for users to invest small amounts of money in the stock market which can be a good and fun way to introduce teens to the concept of investing and automating our finances. You should be sure though that you have a good handle on budgeting and managing your money before taking that path.
First we should take a look at the difference between investing in stocks and putting money in something like a bank account. When you put money in a bank, the bank pays you a small amount of interest. The amount is very small, but the advantage is that there is no risk. If you put $100 in the bank today, you know you will have at least $100 next year (plus a little bit of interest, so let’s say $102 or $103). But the disadvantage is that your money grows very slowly over time. With stocks, on the other hand, you are buying tiny fractional shares in companies--some are companies that we all know, like Apple and Netflix and Google. Others are companies we may not have heard of, because they are either much smaller, or else maybe they’re in foreign countries. When you invest in these companies, you are taking some risk. What happens if the companies don’t grow, or worse, if they go bankrupt?
So the downside is that there is risk in investing in stocks. But the advantage is that historically, people who invest in the stock market tend to make much more money over time than people who just put their money in banks. Fortunately, you can do something called diversifying, which means that instead of investing in only one company, you invest in a whole “basket” of multiple companies. That way, if some of the companies don’t do as well over time, there are many others in the collection that should balance it out by performing better over time. “Don’t put all your eggs in one basket.”
Investing early (whether putting your money in banks, or stocks, or both) is an important part of gaining more money earlier. Start by researching banks with high investing interest rates. You could then set aside a certain amount of money either each month or year. Being consistent is key, as is being patient. Over time, that money will gain interest and become larger and larger.
Here’s an example, assuming two people invest in the stock market:
Begins investing at age: 15 35
Stops adding money at age: 30 65
Invests each year: $1,000 $5,000
Invests a total of: $15,000 $150,000
Total grows each year by: 11% 11%
Total worth at age at age 65: $1,473,172 $1,104,566
Of course, the growth won’t be 11% every year -- that’s an average, and historically, investing in the stock market does in fact tend to have returns of about that amount. It may be up one year 20%, down the next year 10%, down the next year 5%, up the next year 5%, et cetera. But on average, 11% is not unrealistic.
What jumps out at you about this example is that even though Bob invests in more money every year, and invests for a longer time, he still has less money than Sally, who invested less. How did this happen? Because Sally started much earlier, and her money was invested overall for a much longer time period.
The importance here is time. And even though this example deals with stocks, there are similar results when you are putting money in a bank or credit union, too. As teenagers and young adults, start now with a dollar or two here and there. The power of compounding is how much you invest (and how regularly) and what the growth rate is. Also how long you let your money grow. You can invest in stocks, saving accounts, mutual funds, and CDs. A CD is essentially a time-bound deposit. In exchange for a higher interest rate, you enter into an agreement to let the bank use your money for a fixed period of time. The bank rewards you by paying you a higher interest rate than it does for a savings account or money market account.
For example: Put $100 in savings account
Put $50 in CD account
Put $100 towards a car or vacation
If you are looking at stock mutual funds, you might consider one called Vanguard’s Total Market Index Fund. A very good practice is to regularly set aside as much money as you can from month to month and year to year. People who have steady jobs often increase their savings steadily until they eventually save in excess of ten percent of their salary each year. You should invest all this money into either some bank account and/or a fund like Vanguard's total market index fund, or both. In funds like these, thousands of investors gather up their cash to purchase shares in a fund that mimics a benchmark index. A benchmark index is a group of stocks that are used to measure the performance of other stocks in the market.
In order to open an investment account you’ll need to be of a certain age. Therefore if you are a minor you can’t technically open up and account by yourself. One way you can get around that is if you have accounts under your guardian’s name then claim it once you turn 18, or you can open an account with your parents called a custodial account. This allows your parents and you to oversee the account.
It may be a while before most teenagers are thinking about working for a company after they’re done with school, but it’s important that they are aware of different retirement plans available at many companies. This section will talk about one of the most common company retirement plans, the 401(k).
First let’s talk about why it’s important to save for retirement. Most teenagers are looking forward to beginning their working career, not ending it—but the truth is, once a person gets out of school and starts working, life happens fast. Many people will find a partner, have children, buy a house, move around the country, and generally get very busy with their lives. It’s strange to think about this, but before you know it, years start going by quickly. Why is this important? Because at some point way down the line, you are going to want to retire. Maybe you know a parent or grandparent who has retired and no longer works. For most people, retirement is a happy time of life when they can relax after many years of hard work, and enjoy the fruits of their labor.
But here’s the catch—once a person stops working, their paychecks will stop, too. So if a person retires at, say 67 years of age, and lives to be 92, that’s a quarter century of life without a paycheck!
In order to be able to sock away enough money for this potentially large amount of time without a paycheck, most people have to save for many years. Unless you are from a wealthy family, or win a lottery, or get a massive inheritance, the hard truth is that it’s very difficult to accumulate enough money to last through your retirement unless you start very early. So if you get out of school, start working, have a family, and generally get busy with your life, there’s the risk that you may wake up some day in your 40s or even 50s and suddenly realize that you haven’t saved any money! In order to avoid this risk, the best thing to do is start saving for retirement as soon as possible. The 401(k) is a great way to do this.
Here’s how it works:
When you’re hired at a company, they tell you about their 401(k) plan. Sometimes you need to work a certain amount of time before you’re eligible, like 30 days or 3 months. Then you decide how much money you want to put into the 401(k) from each paycheck.
· It can be a percentage, like “4% of my pay”
· Or it can be a dollar amount, like “$25 per paycheck.”
That’s half the battle. Once you sign up, the company begins taking your desired amount, and instead of putting it in your bank account for you to spend and pay your bills with, they send it to the 401(k) company to invest.
Why is a 401(k) account better for retirement savings than a bank? Three main reasons:
1. First, there is the opportunity to save pre-tax. The 401(k) is a special type of savings plan that lets you “shelter” any money you save from annual taxes. If you just save money in a bank, you have already paid taxes on the money you put in the bank. But with a 401(k), the money you save is “sheltered” from the government and you do not have to pay taxes on it. So for example if you earn $30,000 (gross) in your first job out of school, and you manage to save $2,000 in your 401(k) during the year, then the government only taxes you on $28,000. A perfectly legal way to hide money from the tax man.
(Added bonus: The money grows “tax-deferred”. We’ll talk about this in #3 below, but basically, the money can grow while it’s in your 401(k) account. You don’t have to pay taxes on the growth while it’s in the account.)
2. Second, many companies offer a “match.” This means that if you put in money from your own paycheck, the company puts in money to “match” yours. Usually there’s some set formula like, “for every $100 you put in, the company will put in $50,” or something similar No bank on the planet will offer to match the money you put into it!
3. In addition, there is a good chance that you will earn more in a 401(k) over time than in a bank. Remember in point 1 we said that the money won’t be taxed as it grows. How do we get it to grow? 401(k)s allow you to invest your money in the stock market. Most plans have numerous options ranging from very conservative (like a money market or CD that you’d find at the bank) all the way up to very aggressive, like stock funds investing in international companies or technology companies. The more aggressive you invest, the better the chance that over time you will earn much higher returns.
Important note – don’t expect great returns every year or every month or every day. More aggressive investments come with volatility, meaning, they can go up and down and up and down like a roller coaster. This is the same point as above, with the example of Bob and Sally. Their growth rate was 11% on average, but as we said earlier, it wasn’t 11% every year and there were definitely years when it was negative. But, historically, the more risk you are willing to take, the higher returns you will see in your 401(k)
In the bank, however, you typically only have the option of much more conservative options, like CDs and checking accounts. Right now (January, 2020) the interest rates on these are very low-sometimes under 1%! And to add insult to injury, you even have to pay taxes on that tiny return because a bank account is not a pre-tax account like a 401(k)!
Remember above, where we said deciding how much to put into your 401(k) is half the battle? The other half is deciding how to invest your money once you are a participant in your company’s 401(k) plan. As point #3 describes, you will usually make more money if you take more risk (though it can be scary to watch your account go up and down, so buckle your seat belt!). In general it’s better for younger people to invest more aggressively (the stock funds) when they are young and then gradually become more conservative (bonds and money market funds) as you get older. Nevertheless, it can be confusing for a beginner 401(k) participant. Don’t worry, though. Most 401(k) plans offer choices where some investment company manages the investment for you. Most even offer what are called “Target Date” funds that start off more aggressive when you’re younger and then automatically become more conservative as you slowly approach your “target date.” These funds are on autopilot and do most of the work for you!
So the most important thing is to get into your company’s 401(k) plan and save as much money as you can!