Outside the Box: Teach your kid the magic of compounding so they can retire rich


They say youth is wasted on the young, but when you apply that to investing, the opposite is true. 

In fact, youth is on your side when it comes to investing. Developing healthy money management habits early on in life is vital. It will set you up for financial success throughout your career and personal journey. 

If you begin when you’re young, time and compounding are your most important assets. Why, exactly? Well, compounding is the process of your money growing exponentially, or snowballing, over time. 

Say, for instance, that you put $1,000 into the stock market, assuming a 6% annual return. That means that the following year, it will be worth $1,060, and the year after, $1,123.60. 

With compounding, you make money on the initial amount you put in, or the principal, and on the interest or gains each year thereafter. Essentially, you’re earning gains on gains.

Read: Save $1,000 a year, retire with millions

Everyone can benefit from compounding

The benefits of compounding apply to virtually all families. Start contributing $10 per day to your child’s college savings account when they are 1 (assuming a 6% annual return), by the time they’re 18 they would have about $120,000 saved. That’s real growth. 

As you can see, it doesn’t take much effort for your money to grow over time, and investing apps for kids are key to building meaningful wealth. 

For parents, one of the easiest ways to begin educating kids about money is to make it fun and to look for teachable moments. 

For example, open a joint savings or a custodial account for your child. For a savings account, you can work through a traditional bank or online-only bank, and for a custodial account, you can open an account with companies like Fidelity, Schwab, Vanguard, UNest  and more. 

Many of these companies make it easier than ever for parents to open a tax-advantaged investment and savings account for their children. 

If you’re not familiar with a custodial account, it is a financial account that an adult controls, generally a parent or a legal guardian, for a minor. These types of accounts offer enormous flexibility in what you use the funds for, and they can make for a wonderful, highly educational gift for your child. 

Read: Want more money for retirement without a lot of effort? Ask your company about this perk

Healthy money habits that last a lifetime 

Another idea is to set an allowance. Decide on a reasonable amount your child will receive each month for completing specific tasks. This will teach them healthy money habits early on and incentivize them to work. 

You could even go a step further and empower them to negotiate a raise by taking on additional jobs or responsibilities. 

You often have more impact instilling money habits when done as an interactive process. Leverage technology. 

There are a myriad investing apps for minors, products and educational tools available to children and teenagers looking to start investing

These options can teach them about personal finance and encourage learning. Gamifying these lessons is also a fun way to instill these vital skills. 

By making this important aspect of their life fun, not only will children enjoy learning about money, they’ll internalize these lessons, giving them a financial head start in life. 

As children grow and mature, particularly as they reach their teenage years, this presents another opportunity to teach them about personal finance. 

At this point in their lives, they may begin to earn their own income, whether it’s from babysitting, a summer job or walking dogs, and they won’t know the first thing about what to do with this new found money. 

Instead of letting them blow it on something that will only bring short-term gratification, encourage them to put it in the best investments for teenagers and include them in the process. 

Demonstrate how investing now can pay dividends later by setting goals for teenagers. Work with them to establish a list of things to save up for as a teenager and why delaying gratification can often result in better decision-making in the future.

Read: Make your kid rich for $1 a day

Custodial accounts are a gateway to investing 

Since you still have to be 18 to invest in the stock market by yourself, you can overcome this hurdle by opening a custodial account. With a custodial account, parents can give their children things like free stocks and bonds or real estate without major tax consequences. 

Once they are of legal age, which can be anywhere from 18-25 depending on the state, the account transfers to the beneficiary. 

Let’s say you decide to invest your money in the stock market and you want to include your teenager so they learn the basics of investing. For a first-time investor, I would advise against picking individual stocks. Instead, try index funds. 

Historically, over the long-term, these types of investment vehicles tend to outperform other kinds of mutual funds. Additionally, they are low-cost, meaning you won’t pay a premium for a professional stock picker or manager, and they are tax-advantaged and well-diversified. 

It’s important to understand that when you invest in stocks, you don’t want to put all of your eggs in one basket. This way, if one stock goes down, you have other investments to balance out the loss. 

You must also consider fees. If you’re not careful, fees can greatly eat into your returns. With most index funds worth investing in, you typically face low-to-negligible fees. 

Kids come first

I know what you’re probably thinking: Shouldn’t parents plan for retirement or make sure they have an emergency fund before saving for their kids? 

Contrary to popular belief, and even with the strain of the pandemic, parents’ top goal is still saving for their children. In fact, according to a Harris Poll/UNest Survey, 93% of parents with kids under 17 would make a self-sacrifice if it meant their child would have a healthier nest egg. 

What’s even more surprising about these findings is that among parents with young kids (under the age of 17), 44% consider their children as the most important savings goal. Yes, ahead of building an emergency fund, saving for retirement or buying a home. 

That’s why opening a UTMA custodial account is not only smart, parents see it as essential for setting kids on a sustainable financial path for all of life’s stages. 

Technology makes it easier than ever before to make learning about personal finance fun and simple. Take advantage of investing apps for beginners to give your children a leg up on their financial future. 

The earlier you start teaching your children healthy money habits, the better.  This means investing early and often in index funds and contributing regularly to your investment account so that you can take advantage of compound interest to fund all of life’s expenses.

And, of course, it’s never too late to start.

Riley Adams is a CPA and the author of the Young and the Invested website, which focuses on financial independence and investing, and where this column first appeared.

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