ost people assume that investing is an adult affair and that one's teenage years are not the best time to invest due to a lack of resources and abilities. But, most people tend to forget that teenagers have the most valuable resource on their side - time. Due to this time advantage, teens have the upper hand in investing. All they need to do is grasp the power of compound interest, and they may amass a sizable fortune when they grow up.
To invest, one should know how to save. Therefore, teenagers have to learn how to budget their money so that they may avoid unnecessary purchases and build up sizable savings to put toward their future endeavors. Teenagers need their parents' approval and assistance since they lack the resources to invest independently and are not of legal age to do so.
This article will guide teenagers and parents on how to manage expenses to invest as a teenager and how to teach financial management to teens.
Important Financial Lessons For Teens
Before diving into the topic, here are some important financial lessons that every teen should know to get financially prepared for expense management and investing :
Power of Compounding
Compounding means when the interest earns interest. It is reinvesting the interest on top of interest so that your investment can grow exponentially over time. Let's clarify with an example.
So, you opened a savings account and deposited $10,000 with no intention of withdrawing the amount for 30 years. Suppose the interest rate is 6% compounded quarterly. After 30 years, the $10,000 you deposited will grow to $60,000. This is the power of compounding. You can use a compound interest calculator to determine how much your money will increase if you invest now.
Penny Saved Is a Penny Earned
Most teens do not understand the value of money. They spend money on unnecessary stuff based on peer pressure and to keep up with social media trends. It's important to know that a penny you saved now is a penny you earned. So, whenever you make a purchase, ask yourself if you want to spend money on it or keep the money you could save otherwise. This helps in managing your expenses and reaching your financial goal faster.
Get a Credit Card
To make any big-ticket purchases in life, you must first establish a credit history. Most people think getting a credit card as a teenager is a terrible idea since you may end up in expensive credit card debt. But, the sooner you build the credit, the easier it will be to qualify for mortgage and auto loans. Getting a secured credit card with a limit is best, so you won't overspend. However, you must make timely payments to boost your credit score and build good credit history. Your future self will thank you for this step.
Set up an Emergency Fund
Just as it is vital to have first aid supplies on hand in a medical emergency, it is also essential to have an emergency fund to cope with unanticipated financial situations. Even modest savings in the fund may be a lifesaver during hard times.
Budgeting is a crucial life skill. It is a process of creating a financial plan to avoid unnecessary spending and make purchases only when essential. To do this, it is necessary to differentiate between needs and wants. The priority in any budget should be the needs. After that, you can spend on things you want. But you should also include savings in your budgeting plans and decide how much you want to save. Don't use the saved amount unless there is a financial emergency. The key to budgeting is consistency and sticking to it.
How To Manage Expenses?
Savings is the first step to investment. To save, you need to manage your expenses. As a teenager, managing your expenses can be tricky as you are influenced by many things, social media, friends, or the latest trends. If your friend buys the newest smartphone, you will also want it. But, it's crucial to understand that managing expenses are the stepping stone to financial success. Your sacrifice will take you one step ahead of reaching that financial goal.
Here are some tips for managing your expenses:
Track Your Spending
You can only manage your finances when you track where your money is going. So, it's essential to keep records of every expense and analyze at the end of the day if you have to spend money wisely or not. If you think you overspend, keep that in mind while spending later.
Create Realistic Budget
Budgeting is a great way to manage your money but sticking to the budget is the main challenge. After your monthly allowance, classify the amount into different categories: eating out, clothes, school supplies, and transportation. Assign the amount as you require and stick to the budget amount.
Need VS Want
Before purchasing anything, ask yourself if you genuinely need it or not. You should only spend on the things you need, not the things you want. One of the most critical aspects of managing one's finances is learning to control one's impulses and avoid unnecessary expenditures.
Postponing the Purchase
One of the techniques to control extravagant expenses is to postpone the purchase for a while. You can purchase it if you still need it after the delay. But, if you had forgotten it, you probably didn't need it in the first place.
Simple and Easy Investment Options for Teenagers
Due to age constraints and limited budgets, teenagers have limited investment options. However, here are some of the simple and easy investment options:
A saving account is the most simple and straightforward investment option for teenagers. You can save your money and deposit it in high-interest accounts. Set aside small chunks of money from your pocket money or gifts from relatives in a high-interest account. Thanks to the power of compounding, you can amass great wealth that will compound over and over again through the years.
Certificate of Deposits (CDs)
Certificates of deposits (CDs) or term deposits are money deposited for a specific time ranging from months to years. The deposit is then fixed, meaning you cannot withdraw cash during that time. It offers high-interest rates as compared to saving accounts. One thing that makes CDs one of the best investments for teens is that they're FDIC insured and are the most secure investment.
The stock market is the actual game for investors. The sooner you enter the game, the more skillful you will become over time. It's crucial to understand that the stock market is volatile and risky. Any minor below 18 is not eligible to buy and sell in the stock markets. But, you can open a custodial account where the parents will make an account for you. Your parents will make actual trades for you as they have management control over your account, but you can be part of the investment process.
If you have no idea where to start and which company to invest in initially. Just buy the share of the company you love or the big companies such as Tesla, Microsoft, Google, and Apple. You can make money from the stocks in two ways:
The company pays you a certain amount of money from the profit, known as dividends. For instance, if you invested one share in company X valued at $100 per share and a dividend yield of 5%, you will be paid $5. Simply, that $100 you invested earned $5 for you. These dividends are paid quarterly and can be paid in cash or as stock depending on company policy.
Selling stock at a profit
Aside from dividends, you can also sell the stock when it appreciates and make money off the profit. For instance, if you bought the share of company X at $100 per share, it is currently valued at $150. If you sell the share at the market price, you will profit by $50.
Exchange Traded Fund (ETFs)
An ETF, an exchange-traded fund, is a bunch of stocks and other investments all bundled together and traded like a single stock. They are the best investment options for the beginner since it lowers the risk through diversification. Also, you don't have to research and buy separate individual stocks.
For example, let's say you want to invest in green energy. There are plenty of green energy companies you need to research and purchase the stocks from. Instead, you can buy a green energy ETF and invest in the green energy you wanted to. It's the safest option, as even if one company drowns, you have other companies that will keep you afloat.
Real Estate Investment Trusts (REITs)
One of the barriers to investing in real estate is that they require a high amount of upfront capital, which most teenagers do not own. Instead, you can invest in real estate through the real estate investment trust (REITs). Simply, REITs are companies that own or finance investment properties. You can buy the share of the REIT and indirectly earn profit from the real estate trading.
Get a Roth IRA
A Roth IRA is an individual retirement account that lets you contribute post-tax money. Teenage is the best time to invest in Roth IRA. Firstly, you are not making much money now; thus, tax is not much. Next is the power of compounding interest. The amount is multiplied until you withdraw them when you are 60. The best thing about Roth IRA is that it offers tax-free withdrawals. Unlike other custodial accounts, minors don't qualify for a Roth IRA until they have jobs that earn them money.
Mutual funds are a great way to invest in stocks and reduce the risk of the stocks and market volatility. They are a portfolio of different stocks that diversify your risk rather than putting all eggs in one basket.
Start a Small Business
Businesses are great investments. You can start a small business with any business ideas that you have. Simply create a t-shirt business, slime business, or scrunchies business. Start small so you won't break the bank even if you fail. You can reinvest the profits and slowly turn your small business into an empire.
Though teenage is a great time to invest due to the time advantage and power of compounding, teenagers' significant challenges are the fund, legal eligibility, financial knowledge, and parents' permission.
How Can Parents Initiate Money Talks With Teenagers?
The teenage years are the hardest for parents. Generally, teenagers are stubborn as they deal with the transition phase from childhood to adulthood. But, it's a crucial phase since they will soon face real-world problems. It's like preparing the soldier for the war; financial management is a core skill teenagers need to learn to live financially independent lives.
But, the problem is that most families regard money talk as taboo. As a result, teenagers enter adulthood without knowing how to manage their finances. Most teenagers expect their parents to teach them basic skills. But since talking about money is taboo in most families, the communication barrier between teenage and parents regarding finance remains strong. The idea that finance is an adult affair is grounded in our mentality that neither teen makes an effort nor the parents try to initiate the money talks, and the wall remains solid and intact.
It's essential to break that wall and taboo. The sooner parents teach about financial management to their kids, the better they can manage their finances well in the future. The first step to breaking that wall is to talk about money with teenagers. That way, they can be taught how to manage their money. But, the long-kept attitude is hard to change, and initiating money talks with teenagers can be the most challenging task.
Here are some tips for parents to have a conversation :
Share Your Financial Stories
Talks are boring, but the stories are fascinating. So, you can share your financial stories, such as your first job, first salary, success, failures, and mistakes. Tell them how you bought your first car and your first house. Share the money lessons you have learned from your real life.
Involve Them in Financial Decision
Most parents don't involve their children in their financial decision. It's crucial to ask for their advice and include them in the decision-making process. For instance, if you are considering purchasing a new car, ask them which one they recommend under the given budget. Give them two options, tell them to choose one, and ask for the reasons. This will help improve their reasoning and decision-making skills and make them feel involved and valued in financial affairs.
Monthly Budgeting Review
The best way to teach them about handling money is by handing them the money. You can give pocket money to your child and let them budget the funds to meet their goals. Set the long-term goal, which could be the new smartphone they want or saving tuition fees for their college. Give them a monthly allowance, tell them to save, spend the amount, and review the budget together. It won't be just them; you should also review your budgeting and jointly analyze if you used your money wisely or not.
Be Transparent About Your Financial Situation
Most parents don't want to share their financial situation with their kids, especially when they are financially struggling. Understandably, parents don't want to burden their children with this stuff. But, it's essential to be transparent and share what went wrong and how you ended there. You don't need to talk about it in detail. A brief scenario and lesson to the teen would help them learn valuable money lessons so they won't repeat the same mistake.
Learn About Money Together
Most parents don't like talking about finances as they feel they don't know their finances to teach them. Teens are inquisitive and might ask questions you don't know about. But it's okay. Not everyone knows everything. Learn about money together. Let the teens teach you about the latest bitcoins and NFTs, and you train them on what you know about budgeting, mutual funds, and stock markets. This win-win situation helps both of you broaden your financial knowledge.
Teenage is the year of transition from childhood to adulthood. Thus, it's imperative to teach money management skills to teenagers. Also, teenage is the best time to invest as they have a time advantage and an opportunity to fully take advantage of the power of compounding. Starting early can give you a headstart on the savings for the future and learning the importance of money skills and lessons, which help to fulfill the financial goal later on.