Investing as a teenager provides you with a significant financial advantage as you get older. Not only do you have more time for funds to accumulate, but you can benefit from compound interest and youth tax breaks.
Furthermore, investing as a teenager gives you valuable investing experience for later in life. However, figuring out how to start investing as a minor can be difficult. You will need an adult you trust to help you set up and manage accounts.
Let’s take a look at how to invest as a teenager, the types of investments teenagers should consider and the best investments for teenagers.
What is a Custodial Account & How Does One Work?
A custodial account acts as a type of financial account an adult maintains for another person, often a minor. The two basic types of custodial accounts are the Uniform Transfer to Minors Act (UTMA) accounts and Uniform Gifts to Minors Act (UGMA) accounts.
You can set up Uniform Transfer to Minors Act (UTMA) accounts with a large variety of various types of investment accounts. The money in these accounts is controlled by a custodian, typically a parent, and the teen or child doesn’t have access to the funds until he or she reaches that state’s age of majority. For some states that age is 18 and for others it is 21.
Uniform Gifts to Minors Act (UGMA) accounts allow assets to be controlled in a custodian’s name to benefit a minor without the need for setting up a special trust fund. UGMA accounts are held in the minor’s name (meaning the money belongs to the child), but the listed trustee can complete transactions on the minor’s behalf until they are of legal age to take over the account and its investments as a young adult.
You can use money from either type of account for any purpose and only falls subject to taxation at the child’s rate, which varies by age and student status.
For example, let’s say you are under age 19 (regardless of student status) or younger than 24 and a full-time student. In this situation, your first $1,100 of investment income is tax-free. Your next $1,100 would be taxed at 10%. Anything above that would be taxed at your parent’s marginal tax rate. The IRS refers to this as the “Kiddie Tax.”
If your parent or guardian earns income in a high tax bracket, these accounts become less attractive after the $2,200 investment amount. These custodial accounts have no contribution limits. However, anything over $15,000 per year (or $30,000 for a married couple filing jointly) means the federal gift tax needs to be paid. As a result, deposits made in these accounts rarely exceed this amount in any given year, lest the parents or guardians wish to fall subject to this gift tax.
Best Investment Plan for 18-Year Olds and Younger
Diversification is essential for investment strategies at any age. The best investments for a teenager will include a combination of stocks, mutual funds, and exchange-traded funds (ETFs). Stocks are often considered the most exciting type of investment vehicle, but also the riskiest.
→ Consider Paper Trading Apps
Before purchasing stocks, make sure to thoroughly research any you are considering. Some people choose to take investment classes first. You can even create a virtual trading account with a service like Webull to test out making real trades with fake money to know what to expect when you start investing real money.
→ Invest in Individual Stocks
Investing in individual stocks can represent the greatest chance of capital appreciation because they can rapidly outpace a broader basket of stocks you hold in multiple companies. At the same time, this can create a significant amount of risk from lack of diversification, exposing you to the ups and downs on one individual company instead of many.
Growth stocks focus on long-term capital appreciation as opposed to paying dividends to their investors. Depending on your investing objectives, you will need to decide whether you wish to invest for capital appreciation or for income-paying stocks in the form of dividends.
Choosing to invest in dividend-yielding stocks as a teenager can become very lucrative long-term. Dividends represent payments made by companies representing a percentage of their profits given back to investors. The amount you receive depends on the number of shares you own in the company. In quality companies, dividends often (but not always) rise each year. If you reinvest your dividends into more shares, you will get more dividends in an advantageous cycle.
→ Invest in Mutual Funds
You will also want to consider investing in mutual funds. Mutual funds combine investors’ money to purchase several types of investments, such as stocks, bonds, real estate, and more. The fund manager is in charge of trading the fund’s underlying securities. Typically, mutual funds are safer than investing in individual stocks because the risk is spread out among many investments.
You can also benefit from the wisdom of expert fund managers. If you’re underage, you can have an adult buy mutual funds for you through a brokerage account like Firstrade. Alternatively, you can often save money on trade commissions if you purchase funds directly through a mutual fund company.
→ Invest in Index Fund ETFs
ETFs accomplish a similar goal as mutual funds: providing instant diversification. However, mutual funds cost the same no matter what time of day you order them, while ETF prices change throughout the day. This happens because ETFs trade on exchanges like stocks.
In many cases, ETFs don’t have investment managers actively managing holdings as often as mutual funds. In one way, this could mean a more cost-effective investment because this allows you to pay lower management fees. This holds especially true for index funds which track a broad-market index, removing the need for active stock-picking.
My preferred investing strategy relies heavily on ETFs because these provide instant diversification, come with low costs and don’t try to outpace the market’s performance by taking on too much risk. Because of these reasons, ETFs act as a great investment option for teenagers as they work best as long-term investments.
For example, if the stock market has a downturn, you have time for it to readjust in your favor before you sell. Another benefit to ETFs is that your money is liquid. Once you sell, you can use the money for anything you want. Finally, like stocks, some ETFs make dividend payments.
When you receive these dividends, they may qualify as qualified dividends, thus falling subject to the passive income tax rate, which will cost you less in taxes in the long-run.
Why Teenagers Should Consider Having a High-Yield Savings Account
While savings accounts aren’t as exciting (and usually not as lucrative) as other types of investments, there are advantages to opening one. If you’re new to managing money, savings accounts are a useful way to start experiencing the benefits of compound interest and practice restraint from spending money. Plus, once a high-yield savings account is opened, all you have to do is leave it alone for it to start making you profits.
With a high-yield savings account, you can have joint ownership as a teenager, as opposed to a custodial account where you can’t access funds until you reach the age of majority. A high-yield savings account, rather than a standard savings account, will earn you more money. The average interest rate for savings accounts hovers around 0.09% APY.
Some high-yield savings accounts can almost double that rate or amount to far more when interest rates don’t scrape the bottom of the barrel like they have in recent years. The longer you keep money (including interest earned) in the account, the more money you make while you sleep.
It’s common for these accounts to have you lock your money in for a specified amount of time. For teenagers who don’t have bills to pay, this usually isn’t an issue.
When choosing a high-yield savings account, in addition to the interest rate, take into consideration any required fees and the minimum balance amount. It can be useful for you to set goals of how much money you intend to save in your account and possibilities for how you might want to spend it in the future.
Make expectations clear with anybody who has joint ownership of the account. Establish who is allowed to contribute funds, take funds out, and view transactions. A high-yield savings account you might consider with attractive interest rates comes from CIT Bank.
Are Microsaving Apps Worth It?
These can be a fun, gentle way to start investing. Many of these financial apps for teens and young adults automatically round up the cost of your purchases to the nearest dollar. The rounded up amount is then automatically invested.
For example, if you buy a drink for $5.25, then the app would set aside 75 cents and invested according to your selections. Although each contribution is less than a dollar, if you make a lot of purchases, over time this amount can add up and become a passive way to invest without actively remembering to designate deposits.
You can think of these apps as advanced piggy banks. Though, where they outperform a piggy bank, however, is investing the money in assets that appreciate in value instead of the money sitting there (and losing value over time).
Some apps will allow you to set specific rules. For instance, you might set a rule that every time you get fast food from your favorite restaurant, your app contributes an extra dollar to your investments. Most apps will also let you set regular or one-time contributions.
One of the top benefits of micro saving apps is that they are a very “set it and forget it” strategy. The money keeps adding up and you don’t need to make any adjustments to the portfolio option you choose. In addition to these apps’ simplicity, they are great for teens because time is on your side. Your funds have time to add up and any money lost short-term has time to rebound.
How to Start Investing as a Teenager
If you have the ability to start investing as a teenager, you’ll have a significant advantage when you’re older. You can start small with a microsavings account, begin with more substantial investments through a custodial account, or begin saving money with a high-yield savings account. All leverage the power of compounding returns to your advantage.
In the end, no matter which method you choose, the sooner you get started, the better. Consider enrolling in a financial service like Acorns to leverage the company’s bank account, retirement investing and after-tax investing options.
Borrowing on the theme of compounding interest, if you choose to invest just $1 a day from your birth in the Acorns platform, it could total a value of $13,000 by the time a child turns 18. Even better, if you choose to continue investing until retirement (age 65), even without contributing further, the child could end up with more than $400,000.
If you continue contributing $1/day from 18 – 65? The amount could reach almost $500,000 if you assume an average annual return of 7%. If you increase this amount to $5/day under the same assumptions, your investment balance will exceed $1,000,000. As the company’s branding implies, starting small as an acorn allows you to grow into a mighty oak over time. Consider opening your Acorns Early account today and begin investing in your future.
This post was previously published on Youngandtheinvested.com.
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