With the $2,000, I would consider putting half into a domestic equity fund such as SCHB. Today SCHB is priced at $31.26, so approximately 30 shares could be bought. With the remaining $1,000, I would consider an international stock fund such as SCHF, priced at $28.09. Approximately 35 shares could be bought at this price. The number of shares, of course, should all be figured out by the child - it is part of the financial literacy learning.
At this point, having invested, your child has plenty to work with on the investment front. He or she can learn about the dividend yields of the funds, how to find out when the dividends are paid, the holdings in the funds, how exchange traded funds are different from individual stocks and so forth. As time goes by, even the return on the funds can be calculated.
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Two specific payoffs come from this activity. First, when he or she is initially faced with making choices for their first 401k, they will have considerable experience under his/her belt . In fact, they will be able to assess the quality of a company 401k before they take a job. Does it have high expense funds and poor investment choices? They will be able to answer this question.
A second payoff is that the fund has a lot of time to grow. If this is started at the time the child is 16, for example, from proceeds of a summer job and grows at a compound rate of 8%/year, then at age 65 just the initial $2,000 will have grown to $86,000! Even with inflation, this will be real money and, to boot, available tax free, if you believe (huge assumption) the government won't change the law on Roth IRAs!
Disclosure: This information is for educational purposes. Individuals should do their own research or consult an advisor before investing. I own the funds mentioned.
Great tip Robert! How is this reported to the IRS if say, Jr makes money selling lemonade? (Or any job that doesn't have receipts).
ReplyDeleteHere is an explanation "The major impediment to IRAs for children, especially young children, is the earned income requirement. An unmarried person must have earned income of his or her own to contribute to a Roth IRA. The income has to be compensation income, not investment income. And it has to be taxable compensation income. For example, income covered by the foreign earned income exclusion doesn't qualify.
ReplyDeleteThat doesn't mean your child has to actually pay tax on the income. If the total amount of income is small enough so your child doesn't have to pay tax, that's okay. But your child has to have the kind of income that would call for a tax payment if the amount were large enough.
Example: Your child earns $2,350 bagging groceries after school and during the summer. No tax is due on this amount — the only reason to file an income tax return is to get a refund of any withholding. But your child can contribute to an IRA because the earnings are taxable compensation income." From Fairmark.com at http://www.fairmark.com/rothira/minors.htm
Thanks for answering Moneycone's question. Do you believe a even allocation between domestic and foreign equity is necessary for a "balanced investor:" for the "growth" portion of the portfolio?
ReplyDeleteExcellent tip Rob,
ReplyDeleteDid you do anything similar with your kids when they were younger? if yes how did it turn out?
I will be planning on applying this once my kids become of age. hopefully, they will have a minimum of interest in investing by then.
@Shawn Good question. I just throw out a specific recommendation because many people get thrown for a loop when it comes to the specifics in investing. I could go with a small index fund or a portioon in emerging markets etc. The good thing is that since the investor is young they can afford to be aggressive in the stock market. Actually, now that I think about it it could be a good early learning experience on risk tolerance. Thanks for the question.
ReplyDelete@Mich Unfortunately I didn't but by looking at market returns it would have turned out well despite some big downturns as long as, as always, contributions were continued during the down years. You make a really good point about "interest in investing". To me interest picks up when you have skin in the game. For example, poker is totally boring until you're playing for a good sized pot.
Try getting a 16 year old to give up $2000 of their income for a Roth IRA..... that isn't easy, and in this instant gratification world few 16 year olds have that kind of foresight. Great idea, put tough to implement.
ReplyDeleteThanks for the explanation Rob! IRS doesn't specify a minimum age when it comes to Roth. Of course, I'd like to open one as early as possible even if jr can't max out.
ReplyDeleteBut this is a tricky line: "But your child has to have the kind of income that would call for a tax payment if the amount were large enough"
So obviously lemonade stand is out! But other summer jobs may qualify.
@Grouch 16 year old makes $3,000. Have them contribute $1,000 and you match it. Might work for some folks! I agree it isn't easy, especially when saving for college!
ReplyDelete@MoneyCone If you have a child that is filing for a tax refund because they worked at the local pizza hut for the summer then you have this possibility. The 16 year old is an extreme. The key is to get it before the child is in a high bracket.