Step 1: Teach Your Child The Basics of Investing

investing 101: what your kids need to know

Updated March 24, 2023

When it comes to investing, time is money.  The sooner kids get started, the more their money grows.  But how do we get little kids in on the action?  Kids and parents alike need to get a grip on the basics of investing.  Read on for our Investing 101 to help get you started teaching your child about investing their money.  

Investing Basics

To start, investing is putting money you have to work in the hope of making more money.  How?  People invest their money in stocks, bonds, mutual funds and ETFs (among others!) to try and grow their money over time.  Kids should know that investing is a long-term endeavor and helps build a nest egg, or even generational wealth.  

How Do We Get Our Kids Investing? 

When it comes to teaching our kids about investing, Team BT focuses on the fundamentals.  People can either invest on their own, or hire an investment professional to help them along the way.  Either way, investors young and old should stay informed and educate themselves on their investments.  

So where to begin? Let’s take stock 😉 of the basics of investing to set kids up for investing success.  Whether young finance wizzes become active investors by picking their own stocks and bonds or passive investors in mutual funds or ETFs, it’s essential that they understand how they are putting their money to work.

Common Ways to Invest

Stocks

One of the most simple ways to start investing is to buy stock (or equity) in a company.  When investors purchase a stock, they are essentially buying a fraction of ownership in a company called a “share.”  Stocks are typically listed on an exchange (S&P, Dow Jones & Nasdaq are all stock exchanges) and can be traded throughout the day.  When companies list shares on an exchange, they are considered a public company (meaning that individuals outside the company can buy an ownership stake). 

Public companies can do two things with the profits their businesses generate.  They can either reinvest all the money back into the company, or put some of that money back into the company and use the remainder to pay a dividend to their shareholders. These dividends are given as cash or extra shares to investors as a compensation.  In theory there is infinite upside to owning stock, but stock ownership also comes with risks. If a company finds themselves in financial trouble and becomes insolvent, equity holders are at risk of losing their investment. 

Bonds

Bonds are another traditional investment that many people include in their portfolio. Bonds differ from stocks in a few important ways.  While a stock owner buys a piece of a public company, a bond owner does not have any ownership stake in the company.  Instead, bond holders are considered a creditor or lender to the company. Bonds can be issued by both public (one with stock traded on an exchange) and private companies.

While a company’s stock could hypothetically be listed indefinitely, a bond is only outstanding for a set period of time. A bond’s maturity refers to the number of years it will take the borrower or company to pay back the total amount (or principal) that they initially borrowed. Most bonds mature after five, ten, or thirty years from the date they were first issued.

In addition to having a set maturity, most bonds have a set coupon or set percentage that the company pays holders as compensation for lending them money.  Bonds are considered a safer investment, not only because of the set maturity and coupon, but also because they are first to get paid back in the event the company goes bankrupt. Investors can assess the likelihood that a company will go bankrupt by looking at its credit ratings. Independent credit rating agencies determine a company’s credit rating. The highest or “safest” companies (companies that are extremely likely to pay back all principal) are given a credit rating of AAA, while the lowest are rated C.  While ratings are not guaranteed, they do offer investors guidance.

There’s no doubt that bonds are a bit more complicated for kids.  Here’s how the BT Moms break down explaining a bond to your child.  “Let’s say Company ABC needs to build a new factory to expand its business, but does not have the cash to do so.  One way Company ABC can fund this cost is by borrowing the money from investors. If Company ABC borrows $1,000,000 from bond holders, they might compensate lenders by paying 5% annually (this is called the coupon). In five years, Company ABC will also give back lenders the initial $1,000,000 they borrowed.”

Mutual Funds vs. ETFs (Exchange Traded Funds)

Some investors choose to put their money in mutual funds.  A mutual fund pools money from different investors to invest in a portfolio of stocks, bonds, and short-term debt.  Investors buy a piece of that portfolio, or shares in the mutual fund, and make profits when the mutual fund grows. 

Mutual funds give investors more diversity, and therefore more security, than owning a single stock. Mutual funds are actively managed by investment professionals, meaning portfolio managers pick stocks or bonds based on a fundamental analysis and investment strategy.  Mutual funds can invest in stocks, bonds or a mix of both.  Lastly, they can only be traded once a day following the close of the market.  

ETFs (or Exchange Traded Funds) track an index, sector or even individual commodity.  One well-known ETF is SPDR S&P 500, which simply follows the S&P 500 index.  Unlike mutual funds, ETFs are passively managed and offer instant liquidity, meaning they can be easily traded like a regular stock.  

The Bottom Line

There’s no time like the present (and no amount too small!) to get started.  Start the conversation with your child about investing. Fill your budding Benji in on the basics of investing and put those allowance dollars to work!

Ready for more?

Here is a guide to stock selection for you and your child.