Investing for kids

Investing for kids is a topic that has great importance, not only for the child but the parent as well. What we learned about money growing up can be a telling sign of how we use, manage, and spend our money.

Investing can be an intimidating venture especially if you are getting into for the first time. However, with thorough preparation there is no reason to be worried. You should however let your kids understand that like any other venture, investing too has its risks. Without the right information, there is a high probability of losing everything you have invested.

Below are a few guidelines to help beginners minimize the risk of losing their capital;

1. Have an emergency fund – Since building a stock portfolio takes a long time coupled with volatility of financial market, you should keep aside some money for short-term cash needs.
2. Create a budget – This helps you track your incomes and moderate your expenses. Failure to budget your finances leads to subsequent failure as an investor.
3. Understand your economics – Lack of basic economic knowledge leads to a majority of investors losing a lot of money.
4. Extensive Research – Do an in-depth research on the various areas where you are going to invest in. Reading widely about the companies you intend to invest in gives you an upper hand when it comes to investing.
5. Trust your instinct – Past research has proven that following the masses doesn’t produce favorable outcome especially in stock investing. Be a contrarian and take the route less charted.

Many parents want to teach their children about the importance of investing and saving. Most kids when they get to a certain age begin to realize that money can buy them things that they want so they then become eager to learn ways of earning money and how to save so they can invest in something that they want.

This can be a very important time for a parent to really teach the values of money and instill proper ways of spending it to a child and make it a valuable and useful life lesson.

Talk about what it means to ‘invest’ money, not just save it. Investing involves the purchase of different types of assets (real estate, stocks, businesses) so that money grows over time, eventually providing for you when you’re unable to, or don’t want to, work anymore. Explaining the concept of compound interest or compound growth gives your kids a sense of what’s possible.

Benjamin Graham and David Dodd in Security Analysis define an investment as an operation which, upon thorough analysis, promises safety of principal and a satisfactory return.

Invest early. Encourage your kids to begin investing once they have money saved up. The stock market is a great place for them to start; however, do not go out and buy individual stocks or mutual funds. Both are too risky unless you have specialized investment training. Instead, you may opt to invest in the overall market like index funds.

There are several investment vehicles available that allow you to invest in the overall market that are just as easy as buying a stock or mutual fund. Making a simple investment in the overall market may give your child lower risk, more consistent returns and greater diversification. The best part is this strategy is dead simple to do. Once they set up their investment account, they can automate it so each and every month the investment is made for them automatically.

Getting your young adult prepared for the realities of the 21st century is an important part of responsible parenting. Giving them practical financial education before they move out on their own will continue to benefit them throughout their entire life. You would never give your child a car without drivers training; so, make sure you give them a practical financial education before they move out.

Teaching children to save and invest money properly is a lesson that will secure their financial future. Since the day your child was born, you have probably been thinking about saving for their college education. Why not save for college and teach a lesson in financial security at the same time?

There are several different types of investment options available. It may be a good idea to sit down and speak with your children about the options you chose and why. It will be a lesson that will stick with them and help them to make sound financial decisions later in their lives.

You can invest in the following categories;

A) Individual Stock/Shares

A stock is a security that represents the ownership of a portion of a company.

Stocks are also referred to as shares or equity. Therefore, if you own shares of a company, you are entitled to a fraction of the assets and profits of the company in proportion to the amount of shares you own.

If you own shares of a company, you are referred to as a shareholder of the that company. Some companies pay a portion of their profits back to their shareholder after a given period. This payment is known as dividends. Dividend is the amount per share paid by a company to its shareholders.

There are two types of stocks;

Common Stocks – These stocks entitle their owners to vote at shareholder meetings and to receive any dividends paid out by the company.

Preferred Stocks – These stocks lack voting rights but have higher claims on assets and earnings.

Below is an outline of some of the basic steps to take before investing in stocks;

1. Do a thorough research and collect as much information as you can about all the types of stocks in the stock market. Stocks can be large cap, mid cap, small cap, growth or value stocks. Having this information will help you in decide which type of stock you want to invest. Also collect information on the earning history of these companies. Earnings are the profit a company makes. Before purchasing the stocks of a company, thoroughly examine and understand its balance sheet. You should have a clear understanding of its earnings, sales, debt, and equity. Ensure that you read the company’s annual and quarterly reports and review any filings with the Security and Exchange Commission (SEC). It is your sole responsibility to determine if your investments are viable even if you are using a broker.
2. Clearly define your goals. Are you investing in stocks for cashflow or for capital gains? In other words, are your investment goals long term or short term. Having a clear goal at the onset helps you to devise a proper investment plan.
3. Define your risk tolerance. Let your child understand that investing in stocks is a risk. There is no guarantee that his/her money will be safe. He should therefore decide on the amount of money that he wants to invest in stocks. This should be money that he is willing to lose.
4. Design your investment portfolio. A stock portfolio should have as little risk as possible. This can be achieved by investing in different stocks and across different sectors. This is known as portfolio diversification. After designing your portfolio, you must track its performance on a regular basis in order to cut your losses on stocks that are not performing as per your expectations by selling them and replacing with better performing stocks.
5. Decide on how to manage your portfolio. Do you want to manage your funds yourself or you need the services of an investment manager? If you have enough experience and are well conversant with stock investing rules and have acquired expansive knowledge of different techniques, strategies, tools, then you can manage your funds on your own and earn good profits. Otherwise, you will require the services of an investment manager to take care of your portfolio and take decisions on when to buy or sell your position.

Any investor who wants to invest in stocks cannot make direct investments in stock market. He therefore needs the services of a stockbroker, since he is the one who has a direct link to the stock exchange.

The main job of a stockbroker is to facilitate your transactions and guide you in trading with shares while earning a commission on each transaction. He also provides expert advice on the various aspects of the stock market.

Investing in individual stock not only teaches your child about making money, it also teaches them about the value of money. Have them invest in stocks with companies they frequent regularly. Try their favorite restaurant or grocery store for starters.

First of all, be absolutely sure you are financially educated before you begin investing. One of the biggest causes of the market fluctuations we see today is a lack of financial education among most investors. All too often, investors place too much faith in a financial analyst to guide them with their investments. Instead of investing in a company with the eye on long term profit, most people view an investment as a quick hit thing, a way to get in, make some quick money, and sell quickly. The world’s top stock market investors don’t think this way.

B) Index Funds

An index is an investment portfolio that tracks a target index such as the Standard and Poor’s (S&P) 500.

These funds are usually not actively managed and have low expense ratios leading to high yield in the long run

The following advantages of index funds make them attractive to investor:

1. Lower costs – Index funds have low fees and costs due to the passive management of the funds.
2. Tax Efficiencies- There are fewer transactions and or turnover in index funds leading to less taxation due to capital gains.
3. Diversification – An index funds invests in all or most of the shares in the index that it is tracking thereby providing a greater level of diversification. This also helps the investor to reduce risk.
4. Performance – Index funds consistently outperform the vast majority of actively managed mutual funds and individual investors due to the low turnover.
5. Simplicity – It is simple and transparent to invest in index fund due to the passive management and low turnover.
6. Superior to stocks – The diversification, low turnover, less research and low annual fees makes index funds a better choice to stocks.

C) Mutual Funds

Mutual funds are a collection of stocks and bonds that are managed by an investment company. Many companies offer special programs for children to purchase mutual funds. And the investment for these funds is fairly low which is a great option for kids.

There are three main types of mutual funds:

Equity funds – These are majorly composed of common stock. They usually carry more risk and earn more returns.

Fixed-income funds – These consist of government and corporate securities with a fixed rate of return. They are generally considered low risk investments.

Balanced funds – These funds consist of both stocks and bonds.

Mutual funds can be further categorized into groups as shown below:

1. Based on the structure into.

• Open-ended funds
• Close-ended funds
• Interval funds

1. Based on the investment objective into;

• Growth funds
• Income funds
• Balanced funds
• Money market funds

When choosing which mutual funds to investing in, bear in mind that most of these funds are actively managed and have high portfolio turnover and therefore will have high management fees and low yield in the long run when compared to index funds.

D) Bonds

Bonds are financial securities with a definite time limit that are issued by both public and private companies and redeemed at maturity.

Most bonds pay interest biannually at a given rate depending on the market conditions. Because bonds are less volatile than stocks, they are considered the safer investment.

When you buy a bond, you are loaning the issuer money that will mature at a set period of time and can be redeemed for the initial cost plus and interest.

Bonds guarantee a return of the entire principal and some interest to the bond holder at the maturity of the bond provided that there is no default in the issuing company. Bonds also provide a predictable and regular source of income.

Bonds can be issued by the Government Treasury Department, states, cities, corporations and companies to finance their operations. Bonds by federal governments are the safest as there is usually no risk of default.

Savings bonds are an excellent strategy to help secure your child’s future. The good thing about savings bonds is that they continue to grow over a period of time and can be used in a variety of different ways. Even if your child decides to pursue other interests, and doesn’t go to college, the money will still be available for their designated purpose.

E) Real Estate

When planning for kids’ investment, real estate investing is one of the best places for kids’ investment. You need to understand the sooner you invest the more your kid would gain out of it. It is also true that once you start investing in kids’ future, their retirement life would be safe and secure. There are two ways in which you can make real estate investing for kids. First, you might teach your kids the worth of money and its role in life. Secondly, the kids themselves are looking for a high-quality investment plan. This would be really good as teaching your kids how to plan for investment is a lesson that would have impact for a lifetime.

Of all the reasons of real estate investing for kids, one of the most powerful might be to pay college fee for your children. After all, a good education could offer a very useful foundation for success all through a child’s life. For sure, you have learned that saving is a good factor. Let your children recognize that you are investing for their future. And let them see the consequences periodically.

Another place to consider when investing in real estate for kids in Real Estate Investment Trusts (REITs). This involves investing in a company that owns and operates real estates. REITs issue units (much like stock /shares) that give investors access to the income generated by the REIT’s property portfolio. This route is easier and easily accessible as opposed to purchasing properties to rent.

You can invest in REITs by buying stocks or shares of a given company. This entitles you to receive a percentage of the profits earned by that company as dividends. The money generated by the REITs from the various investors is used to expand by investing in new lucrative real estate deals.

REITs allow the average investor to participate in the real estate market through passive investments (through the purchase of company stock or exchange traded funds) and without having to buy and manage properties. Through REITs, you can invest in real estate with no leverage, no property and no stress of managing the rental properties.

Advantages of REITs

Diversification – Since REITs have a good potential of paying dividends and are un correlated to equity markets, they offer investors diversification against future market fluctuations.

Built-in management – Every REIT and its corresponding property investments have their own management team sparing investors the laborious work and time of.

Tax advantages – REITs are exempted from paying federal corporate income taxes and are obligated to distribute at least 90% of their annual taxable income as dividends, eliminating double taxation of income.

Inflation protection – Rents usually rise faster than inflation making equity REITs whose major income is from rents to be an inflation hedge.

The main disadvantage of REITs is the lack of industry diversification since all their investments are majorly property investments. REITs are also greatly affected by the prevailing interest rates.

The different types of REITs are;

• Equity REITs
• Mortgage REITs
• Hybrid REITs
• Retail REITs
• Healthcare REITs
• Office REITs

Below are some of the things to consider before investing in REITs;

1) Dividend yield – It is advisable to choose a REIT that with a reasonable dividend yield. A yield of 6 – 8% is acceptable.

2) Leverage/Gearing – Look for trusts with a low gearing as this makes debt refinancing easy.

3) Growth Potential – Active and conservative acquisition of properties increases the shareholder’s net asset value and dividend yield.

4) Sector – Sectors with less volatility leads to consistent dividend yields and are therefore preferred.

5) Sponsor
A stable sponsor will determine to the success of the REIT in refinancing its loans.

F) Direct Investment Plans (DRIPs)

Direct investment plans or DRIP’s make investing so easy even kids can do it! Since these investment plan allows you to start investing at a young age this is a great investment for your kids that helps you to build your wealth over time. With a commitment to investing at a young age this can mean great returns for you or your kids as they get older.

This return happens due to the passing of time, as your investment grows and gains interest, you get to sit back and reap the benefits of that return. This idea is based-off compounding and can be a very good choice to look into while researching places to invest your money if your young or if you are looking to invest money for your kids.

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