How to set your children up for investing success
Instilling financial literacy in your children at a young age can provide an undervalued head start in life.
The data is clear – more young people are investing than ever before. Recent studies found that almost 40% of Gen Z investors hold Australian equities with this number expected to rise. As Gen Alpha matures this pattern will undoubtably follow suit.
As social media democratises the flow of financial information and resources, young generations are looking to alternative avenues of wealth outside of the 9 to 5 pipe dream.
There are numerous reasons as to why this this is happening; however, this article does not aim to rationalise those notions. Instead, we explore what advice to provide to children when they begin investing (in the off chance they feel like listening).
Are you ready to invest?
Before anyone invests, there are several things to consider before taking the plunge.
Whilst ease of accessibility on financial platforms is driving increased market participation in young people, this can often be a detriment to returns.
When I began investing at 19, I knew very little other than how to open a brokerage account. As I have explored in a previous article, this led to me making a series of poor investment decisions and losing all my savings.
It is important to ask the following questions when your teens begin to invest:
- Why are you investing?
- What is an appropriate risk level?
- How do your goals affect your portfolio?
- What type of investments do you plan on making?
- Which asset classes should you consider?
- Which investments should you select?
- How frequently do you wish to check your portfolio?
You can explore our article 7 questions to ask yourself before you invest for a deeper understanding of what you should investigate before making financial planning decisions.
Morningstar has an abundance of resources on what to invest in, however this revolves around the important conversations to have with your children when they begin investing.
Define a goal
Diving into investing can be quite a thrilling prospect to those starting out. This is why it is crucial to define goals and develop a plan to achieve them.
As engagement in personal finance and investing spreads through social media it can be difficult to clearly define your ‘why’ at an early stage. Sometimes it is purely driven by the fact that everyone else is doing it and appears to be successful.
Whether the goal is to help fund backpacking through Europe for 6 months or to save for a house deposit, bridging the distance between your present circumstances and future goals can only be accomplished by investing. Once goals have been established, defining a time horizon and quantifying the cost of each goal helps guide your eventual investment strategy. When defining long term goals, it is important to consider that inflation will play a large part in costs changing over time, therefore your end number may change.
Like many, setting realistic goals was not on the agenda during my teenage years. At 16 I recall that my life goal was to be a popstar, or a spy, and somehow own a Porsche 911 before I turned 21. As the childhood sentiment begins to fade these are now laughable. To my 16-year-old self they felt reasonable. That is why it is important for young investors to set realistic goals that have foundation in your investment purpose. 9 out of 10 times, trading Bitcoin will not buy you a Porsche, despite what that influencer on Instagram insists.
You can read this article on How to set an investment goal and 5 steps to create an investment strategy for a comprehensive overview of the process.
The early bird gets the worm
For most teenagers, the concept of investing for retirement is difficult to prioritise amidst other (arguably more exciting) opportunities to spend money.
However, starting at an early age is crucial. As a young investor, time is your strongest ally to take advantage of compounding. Emphasising the benefit of starting early can significantly affect a retirement nest egg and avoid having to play catch up later in life.
The chart below highlights this concept showing what a singular $1 investment at different stages of life looks like at 65 when it’s time for retirement.
Note: Assumes 6% return.
The above illustrates that a $1 investment made at 20 years old would be worth $13.76 compared to that same investment made only 5 years later at 25 would result in 25% less ($10.29) at retirement age. When investing for the long term, we can conclude that a later start on investments puts an individual at a significant disadvantage for their total returns and would require a higher contribution to play catch up.
For those interested in exploring the numbers, my colleague Mark LaMonica wrote a great article about the power of compounding where he walks through different models of compounding returns based on staggered periods of contribution. Mark found that compounding is a powerful driver of wealth accumulation with those who begin early building more wealth despite contributing the same principal than those who didn’t start contributing till later.
Stay the course
The get-rich-quick sales pitch is as old as time, however social media has enabled individuals to easily influence mass audiences with unverified information. Often platforms are littered with influencers flaunting lavish lifestyles and selling various courses on trading and cryptocurrency, promising similar abundance for those who subscribe. Inevitably, younger people with more exposure to this are most at risk of buying into the hype, which brings the importance of instilling sound principles before investing.
The market – much like a teenager – is volatile often leading to irrational, emotional decision making by investors. Among this, Morningstar’s investment philosophy champions the long-term outlook. Erratic market movements can incentivise reactionary investing (trading in other words) as we saw after the Trump election last November.
No matter what brand of crystal ball you own, it is impossible to consistently time the market successfully. Research has found that spending more time in the market and employing a ‘buy and hold’ strategy generally derives better returns than a valuation driven approach that involves buying low and selling high based on market movement.
Research from the University of Colorado at Denver found that young, inexperienced investors tend to be overconfident at start. Over time they become more risk averse after experiencing poor outcomes. It is important to consider that despite a stream of challenging world events, markets have demonstrated an overall upwards trend.
Dividends can also be paid through memories
Some advice for the most cautious and frugal teens. Financial guidance has historically been quite black and white – save X% of your income and dedicate Y% for your expenses. This advice is omnipresent, perhaps because it is the most basic and rational take on personal finance. But the payoff from an investment doesn’t always have to be financial.
In my late teens I spent a sizeable chunk of my income from my part time job on travelling. Although that is not typically the suggested course of action, I have never once regretted forgoing the opportunity cost of investing that money instead. I still reminisce of those days fondly and appreciate the personal growth and experiences that came from taking advantage of a generally burden-free time in life.
Memory dividends – as many call them – refers to the notion that the memories of pleasurable experiences pay an unquantifiable and ongoing dividend over the course of your life. At the risk of raising philosophical arguments, I believe memory dividends are a foundational aspect of the human experience.
Money can buy just about anything besides time (that we know of). Whilst it is important to begin investing early and laying ground for the future, it is crucial to indulge in the present and take the time to invest in experiences as well.
