Prudent investment tips for the young

(NYTIMES) – This year, online Robinhood and its millions of younger-than-average customers have found themselves at the centre of attention that is comic and tragic.

“Robinhood: ‘We now allow teenagers with their parents’ credit cards to trade stocks'” went the April headline on satire site Stonk Market. Two months later, the headlines were far more sobering, after a 20-year-old killed himself, leaving behind a note about his negative Robinhood balance.

Robinhood’s customers trade fast – often in particularly volatile types of investments – and can lose lots quickly. Customers have gone to its headquarters in Menlo Park, California, to complain, and the company has installed bulletproof glass.

All of this activity frightens many parents and with good reason. But owning just a few shares of a company’s stock is something else entirely, and it need not lead to ruin or ingrain bad investing habits. It can be the way to build good ones.

Learning about financial risks can be challenging for children whose families have never faced much economic hardship. Nevertheless, it’s a crucial lesson.

The best way for most people to save enough for retirement is to start early, invest most of the money in stocks early on and hang on tight for half a century.

Watching with dread or exhilaration as balances fall when the market swoons or rise when it booms can lead to poor decisions. The earlier someone experiences that volatility and learns how to react to it, the better.

Why stocks for teenagers then? They offer regular score-keeping and the possibility of a bit of real pain when the stakes are lower than they are when managing larger amounts of money. Erect the proper guardrails, and stocks can teach your emerging adults valuable lessons.

THE RIGHT ACCOUNT

It may be tempting for parents to simply open a regular account and trade with their children, but a better option may be a custodial account, which an adult sets up for a person who is not yet 18.

It may come with lower taxes on any gains, although the overall balance is subject to the calculations of college financial aid examiners. Ask questions about trading commissions, account fees and any minimum balance requirements. Also, inquire about whether you can buy fractional shares of individual stocks that may have high prices for even a single share.

THE RIGHT RULES

There are some guidelines that you as a parent, relative or mentor ought to set. Stick to basics for the first few years, which means no short sales, options or use of debt to buy on margin.

Then there are the investment firms’ rules, which adults sometimes ignore. Charles Schwab, Fidelity and TD Ameritrade had a pretty much unanimous refrain: Don’t give children the account passwords so they can trade on their own. And if you do, don’t come running to us for help if they make some gonzo bet that doesn’t work out.

SKIN IN THE GAME

Like so many newbie investors in the 1990s, I was set on a straight path by columns from The Wall Street Journal’s Jonathan Clements, who used his own children as guinea pigs in delightful ways.

In an interview last week, he reminded me of one failed test, in which he doled out a bit of money and then held a mutual-fund-picking contest. His son lost to his dad and his sister, but he didn’t seem to care or learn all that much from the experience.

Best, then, to have kids invest money they have earned – so they can recall the hours of toil it took to assemble their little all.

SET A GOAL

In a spirited Twitter exchange and follow-up article in June, Morningstar’s director of personal finance Christine Benz expressed serious reservations about buying individual stocks if you’re a new investor. People who invest in them, after all, tend not to earn as much over time as those who just put their money in a mutual or exchange-traded fund that owns scores of individual stocks.

Why not have novices invest in index funds from the get-go?

Well, that can be boring. Also, individual stocks get teenagers thinking about larger economic forces: Why is this company performing better than another? And the dizzying losses that are more likely with individual stocks can teach a valuable early lesson.

When Ms Benz and I chatted recently, we agreed on this: Any stock investment must begin with defining the point of the exercise. And that depends on the teenager, too.

“What really got me stoked was achieving a goal,” Ms Benz pointed out. A shorter-term objective like saving for a bicycle probably would have motivated her to take less investment risk, not more. That would also have had her avoiding individual stocks.

THE UPPER LIMITS

One downside of teen stock ownership is the upside.

Big gains can make you feel invincible. It is a real danger now, given how well some technology stocks have performed of late.

Mr Clements has a suggestion: Set a limit on gains in any stock. Once past that point, sell enough to capture all the winnings and put them in a basic index fund.

Then you have an experiment cooking, in which the money that you have left in the stock faces off against the new fund. That fund will zigzag far less than the stock, most likely. Hopefully it ends up as the better performer, reinforcing the lesson that diversifying your investments is a smart move and creates less anxiety, too.

But even if single-stock gunslinging does net a windfall for a young investor, that exposure to mutual funds will count for something.

After all, they make up the backbone of workplace retirement plans, and those funds are the best routes to long-term financial security for most investors. Owning a bit of stock should also help young investors know what to do by the time they enter the working world.

“With any luck, it will be the trigger that excites them about investing and turns them into someone investing in the stock market for the rest of their lives,” Mr Clements said. “If you can do that, the payoff is huge.”

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