Investing Tips For Teens

Practical Steps to Teach Kids to Invest Young

Choosing individual stocks or mutual funds can be confusing plus for the non-professional both are too risky! That's why when you teach kids to invest, teach them practical investing techniques that teens and young adults can implement. Teaching investing for teens is a cornerstone of financial literacy education.

Stock market financial literacy education

An ideal investment for teens and young adults to get on the road to financial independence are broad market index investments. An index is a group of stocks that collectively represents a larger group. Index funds basically allow investors to buy a bunch of stocks that mimic the performance of the entire stock market, in the hope of replicating a successful trend. Since you're investing in the overall performance of the market, this greatly reduces the risk of investing in a single stock.

Broad market indexes allow teens and young adults to generate investment returns similar to the overall market performance. So when you invest in the S&P 500 broad market index, you are actually purchasing a fraction of all the 500 stocks in that index. Broad market indexes that match closely the overall return of the stock market earn higher returns for investors than the average mutual fund. The smallest broad-based index is the Dow Jones Industrial Average, with 30 industrial stocks; the largest is the Wilshire 5000, with over 5000 stocks in one fund. Also popular index investments include The Standard & Poor's 500, NASDAQ 100.

Broad market indexes are where teen investors that don't want to watch the market everyday should be investing their money. If history were an indicator of future performance, it would be clear that over time, you would generate excellent returns. The key benefits associated with broad market index investing are:

• Higher Returns - Over the last 10 years, broad-based index funds have beat the returns of the majority of all mutual funds. In fact, according to Standard & Poor's, less than 30% of managed funds in 2006 beat broad market index investing.

• Lower fees - Mutual funds fees are typically around 2%, while index funds that mirror market returns should be under 0.5%. Spot the difference? Index investingmakes dollars and sense.

• Passive investment - Investing in index funds requires less stock market education and minimal time to track investments.

In any case, our predominant focus is teaching kids to invest with broad-based index funds that have similar returns to the overall market, because then we are receiving similar returns while hedging our portfolio - again, investing for teens is all about diversifying to improve your chances for financial success.

Teaching teens to invest in indexes?

There are two ways for teens to invest in broad market indexes. Both are similar in their returns but are different in how the index is bought, and have different fee structures.

• An Index Fund is a mutual fund that purchases all the individual stocks that make up an index in order to match that overall market. Funds may require a high minimum investment, but it can be waived with a direct deposit investment plan that takes money every month from your account. Typically, fees on index funds are higher and there are minor restrictions on when you can sell.

• An Exchange Traded Fund (ETF) is similar to an index fund, with the benefit that EFTs can be bought and sold like stocks. In this case, look into "Spiders" (American Stock Exchange: SPY symbol) - each share of a spider contains one-tenth of the S&P 500 index, and so trades at roughly one-tenth of the S&P level. They are exchange-traded funds and, therefore, they trade like ordinary shares on the stock market. Perfect for teen investors who believe in passive management. The management fees on ETFs are low. In addition, they can be bought or sold anytime the market is open.

Teenage investors will achieve similar returns whether investing in index funds or exchange traded funds, but ETFs have lower fees and fewer restrictions, so it is a better way to invest in broad market indexes.

Teens and Money - how to invest successfully for the long term

There is an investing technique that will drastically reduce market risk and allow young investors to benefit from long-term growth. This technique is called dollar cost averaging, and is the perfect technique to combine with broad-based index fund investing.

Dollar Cost Averaging - The teenage investor's best friend
Dollar cost averaging allows young investors to invest in broad-based index funds by slowly buying smaller amounts of the index over a longer period of time. This simple yet powerful technique will enable you to reduce your risk and supercharge your returns. If the price goes down, you're able to buy more shares, so when the index goes back up you own more shares. The effect of dollar cost averaging is that it spreads the cost basis (prices at which you purchase the index) over several years, insulating you from short-term price corrections.

Diversification
Diversification is an important step in developing a successful 'investing for teens' game plan. Diversification is defined as spreading investments among many different securities or sectors to reduce the risk of owning any single investment. Fortunately, when you invest in broad based indexes you are diversified.

For example, if you put money into a SPY (S&P 500 index ETF), you literally own a fractional interest in every one of the five hundred stocks that make up that index. So if one stock in the S&P 500 has bad news and drops 50% of its value, you're only invested 1/500^th, and you won't see too much negative effect from that. In comparison, if you just owned that stock by itself you would have lost 50% immediately.

How to Create a Dollar Cost Averaging Plan

To create a successful dollar cost averaging plan, all you need to do is take two simple steps:

1. Budget the exact amount of money you can invest each month. It is important that amount is consistent; otherwise the plan will not be as effective.
2. At set specific intervals (weekly, monthly or quarterly), invest that money into the broad based index fund. Your broker should have an automatic withdrawal plan that automatically will transfer money from your checking account.

A sample plan

Young investors should only invest once you have financial literacy education, your six-month emergency fund, and have at least another $500 set aside to invest. You have chosen the S&P 500 broad based index or similar index to invest in. You determined that you will invest $100 monthly into this index (automatically every month).

In the dollar cost averaging plan above, if you were to invest $100 per month you would own 131 broad based index shares after one year. Your investment would of increased in value $376!

In comparison, if you did not follow a dollar cost averaging plan and purchased $1,200 worth of shares at once, in January, your return would be $240. You would own 120 total shares ($10 cost per share divided by $1,200 investment = 120 total shares). Now do you see how dollar cost averaging can work for you?

Financial literacy education should not only cover teens and money but should include practical investment formulas that teach kids to invest while they are young.

Vince Shorb provides free video financial literacy education for teens at www.FreeBy30.com. His course 'Financially Free by 30' guides young investors, with the use of audio, video and interactive tools, to gain the financial literacy education teen investors need to make it in the real world.