Investing Options for Children and Teens: A How To Guide

My Experience

In a previous post I discussed how to teach kids about money in a fun and engaging way. Today, I’ll delve further into how kids under 18 can learn about investing. There’s nothing like setting up kids for adulting success by teaching them helpful lessons early in a fun way.

I have personal experience with this, having recently opened up a custodial brokerage account for my nephew. He’s 9-years-old and is saving for a trip to Japan he hopes to take when he is a teenager. Together, we discussed many strategies for him to earn money as a very precocious kiddo.

One strategy I mentioned with practically bated breath was investing in the stock market. I didn’t expect him to have any interest because, let’s be honest, how much do adults usually want to talk about investment strategy? My informal research suggests, very few of them. So I was pretty thrilled when he became excited about the idea and asked me to open him an account.

Since that conversation with my nephew, I have helped him fund the account, taught him about index funds, and discussed how the stocks are doing each month. It’s been a fun way to teach my nephew about personal finance, help him save for his trip, and bond.

If you’re interested in opening a custodial brokerage account for any of the children or young adults in your life, but don’t know where to start, I’ll guide you through it. Here, I discuss some of the best custodial brokerage options out there, as well as the pros, cons, and alternatives for a custodial brokerage account.

Table of Contents

Why Should Children Learn About Investing?

Builds a Strong Financial Future

If you’re on the fence about whether to open a brokerage account for your child, there are a few important benefits to consider. First, investing in the stock market is key for most of our financial futures. For those hoping to retire one day, the stock market is the only reliable method for beating inflation over time. Yes, even more reliable than real estate. Plus, the earlier you start investing, the more you’ll benefit from compounding and the more your money will grow. 

For example, let’s say you invested $150 into a custodial brokerage account each month for a child. Assuming an average interest rate of 7% (the historical average), after 5 years, you would have invested $9,000 and earned $1,800 in investment returns. After 10 years, you would have invested $18,000 and earned $7,948 in investment returns. And after 15 years, you would have invested $27,000 and earned $20,193 in investment returns. This example shows the power of compound interest for accelerating returns over time.

Consequently, if you help the children in your life invest early, you will not only help them become comfortable with the stock market, you will set them up with a passive income stream and give them a head start for a strong financial future.

Cultivates Financial Literacy

Additionally, successful investing involves planning and saving for the future, as well as deferring gratification. Indeed, financial advisors recommend that you only invest for long-term goals that are 5 or more years out. Consequently, investing is a great way for children to gain practice saving for the future and cultivating long-term dreams they care about. These skills then help children develop into financially savvy adults.

Finally, the stock market can be a useful, practical forum for building children’s math and research skills. Consequently, investing can serve a number of educational purposes that help young investors apply educational skills in the real world.

What Are Custodial Brokerage Accounts?

Hopefully now you’re feeling interested in helping the children in your life open an investment account. So what is a custodial brokerage account? A custodial brokerage account is an incredible type of investment account for helping younger generations invest in the stock market. Basically, custodial accounts are investment accounts that are opened with a financial institution, mutual fund company, or brokerage firm by an adult on behalf of a child under the age of 18.

The custodial adult then manages that account on behalf of the child or young adult. When the child turns 18 to 25 (depending on the state), they gain control of the account.

For many custodial brokerage accounts, the adult custodian does not have to be a legal guardian. An aunt, uncle, godparent, grandparent, or even family friend could open the account. You just need the child’s social security number, date of birth, and usually a few other pieces of information.

The adult account holder can then invest money or assets on behalf of the child. A key point, however, is that the custodian must always act in the best interests of the child. Consequently, money can only be withdrawn for purposes that benefit the child. That definition is very vague, however, and can include things like school expenses, new clothes, a trip, anything the child directly benefits from.

How Can a Child Become Involved?

If an adult custodian is in charge of the investment account, to what extent does a child actually get to learn about investing?

The extent to which the child is involved in this process depends on both the child’s and custodian’s preferences. For example, a child could make at least some of the investment decisions. As a custodian, you might decide that half of the investments (or more) go into a safe index fund like the S&P500. The other half could go to companies that the child picks and is interested in. If stocks go up or down, you might do a little research with the child to figure out what is happening at the company or in the industry to precipitate that change.

When the broad market index fund I invested in for my nephew went down after the US’s credit rating went down, we had a discussion about credit scores. Consequently, it gave me a good opportunity to talk about debt and credit.

Additionally, the child could help fund the brokerage account by contributing some of their allowance or wages. This may have the added benefit of increasing their interest in the brokerage account and its performance.

And perhaps most importantly, the child can set goals around what the money will be used for and when it will be withdrawn. You should discuss with the child that the stock market should only be used for long term financial goals (goals over 5 years). Any shorter than that, and the returns from the stock market are too unreliable. If the child has long-term goals like college, a trip, car, or even early retirement, you can help them think through how much and where to invest, as well as when and how they should withdraw money.

Types of Investments

Once you decide to open a custodial brokerage account, you’ll have to decide how to invest the money. There are a variety of great investment options for young investors. You have the following options:

ETFs/Index Funds

ETFs, or exchange-traded funds, are very similar to index funds. Both are considered some of the safest and best investments out there. Additionally, they are both bundles of investments that tend to be well-diversified. For example, there is an ETF and an index fund that are based on the S&P500. Those ETFs/index funds are made up of the 500 largest companies in the United States. They both tend to perform well and similarly over time. And they have low fees because they are easy to manage. Nobody has to make a decision of which companies to include in the S&P500 ETF/index fund, they’re automatically updated as companies enter and leave.

Moreover, there are index funds and ETFs for almost every risk level. Those who are less risk averse may prefer investing in an index fund/ETF based on small businesses that has higher risk and potentially higher reward. In contrast, those who are more risk averse will likely prefer an index fund based on a broad market index of large companies.

While ETFs and index funds are similar, ETFs are more tax-advantaged and generally require a smaller initial investment. Many people prefer them for this reason. Financial advisors generally recommend putting most of your money in ETFs or index funds that are based on a broad market, like the S&P500.

Mutual Funds

Mutual funds are actively managed funds of investments. Like ETFs and index funds, they tend to be reasonably diversified. Plus, there are a variety of types of mutual funds you might invest in depending on your risk tolerance. However, mutual funds have much higher fees than ETFs and index funds because they are actively managed. Moreover, their performance has tended to be worse than index funds and ETFs. Consequently, certified financial planners do not recommend their use as much as in the past, nor do I ever use them personally.

Individual Stocks/Fractional Shares

With investment accounts, you can invest in individual companies. This is a very risky strategy. Certified financial planners largely recommend that you only invest money in individual companies that you are okay with losing. However, kids may become more excited if they have the opportunity own stocks in companies they care about. Consequently, you may choose to invest a portion of a child’s brokerage account in individual stocks that they are excited about.

If you go this route, I recommend looking into companies that offer fractional shares. In other words, you can buy a portion of a stock for a much lower stock price than if you were to buy an entire stock. This is a great strategy if you don’t have much money to invest.

Fixed Income

These assets include bonds, CDs, money market accounts, and treasuries. They tend to be the safest kinds of investments. However, that safety comes at a price. The safer the investment, the lower the returns are likely to be. As of the time of this writing, high interest rates are causing these assets to have reasonably higher returns than usual, so they may be a helpful option.

Brokerage Account Options

There are two types of custodial accounts: Uniform Transfers to Minors Act (UTMA) accounts and Uniform Gifts to Minors Act (UGMA) accounts. A UGMA account is what we typically think of when we consider financial accounts. They can hold cash, stocks, bonds, and other financial assets. UTMA accounts, on the other hand, can include those financial assets as well as more unconventional types of assets like real estate and art. Many financial institutions offer UGMA/UTMA custodial accounts, so you may not even have to make a decision of which types of accounts to open.

The best custodial brokerage accounts require no minimum contribution or fees. They also offer a large range of investment options and good customer support. The custodial brokerage accounts below all meet these criteria. Additionally, many of the companies below are considered to have the best investment apps out there.

• Fidelity
  • Con: None to report.
• Charles Schwab
  • Con: Smaller selection of fractional shares than some companies.
• Ally
  • Con: They do not offer fractional shares.
• TD-Ameritrade
  • Con: They do not offer fractional shares.
• Vanguard
  • Con: Vanguard’s website is somewhat difficult to navigate and not the most visually friendly.
• Acorns
  • Cons: Acorn does have a $5/month subscription fee. However, it is a great option for new investors because its virtual robo-advisors provide easy investing guidance to tailor your investments to your needs. Plus, you can open accounts for additional children at no added cost. You can even open your own brokerage account or retirement account within the same Acorn profile at no added cost. And the platform is easy to navigate.

Custodial Roth IRA

Retirement accounts aren’t just for adults. A custodial Roth IRA is another type of custodial account that adults can open on behalf of children. However, only children earning income through a job can have a custodial Roth IRA. With a custodial IRA, account holders can contribute up to the amount that the child earns each year. Consequently, if a child earns $500 through babysitting in a year, up to $500 can be contributed to the account. 

With most custodial Roth IRAs, money can be invested the same as you would with a conventional Roth IRA. Thus, you can invest in index funds, mutual funds, ETFs, and more. Youth can withdraw this money tax-free if the account has been open for at least 5 years and they are either making a first-time home purchase, retiring at age 59 1/2 or more, or if they experience disability or death. 

Remember that a Roth IRA differs from a Traditional IRA in terms of its tax advantages. Specifically, you can contribute post-tax money to a Roth IRA and then withdraw it tax-free later. In contrast, you can contribute pre-tax money to a Traditional IRA and will pay taxes when you withdraw that money later. There are no Traditional IRA options for children.

Things to Consider

All custodial brokerage accounts share a few important drawbacks and things to consider. First, children’s returns from their brokerage accounts can be counted towards their assets when they are applying for financial aid. Luckily, these assets are not heavily weighted and so make a relatively small difference in financial aid packages.

A second important consideration is that children will have to pay capital gains taxes on earned income over $1,150 in a year. If your child’s brokerage account is relatively small, this is unlikely to be an issue. Specifically, assuming an average yearly return of 7% (a pretty typical year-to-year return for an S&P500 index fund based on past performance), the child’s brokerage account would have to be valued at $16,429 or more to earn $1,150 in a single year.

However, if you plan for your child’s brokerage account to be relatively large, be prepared to file taxes on their behalf. The good news is that custodial brokerage accounts have tax benefits. The child is considered the owner of the investment account. So even if you pay taxes on it, it will be taxed at the child’s rate of 10% for the next $1,150 earned. If the youth earns more than $2,300 in a year, the additional returns will be taxed at the parents’ rate.

Finally, you cannot change the account beneficiary or the gifts you transfer to the account. In other words, once a gift is made to the youth, it can’t be taken back, nor can the account be shifted to someone else.

If you are confused or concerned about any of the ins and outs of custodial brokerage accounts, you may want to consider consulting with an investment advisor. An advisor can provide investment advice and consult on the tax and financial implications of different decisions.

Alternative Options to Custodial Brokerage Accounts

Besides custodial brokerage accounts, there are a few other options to teach children how to invest and/or save money.

Fidelity Youth Account

A Fidelity Youth account is a really cool option for kids to becoming financially savvy. Unlike a custodial account, an adult with a Fidelity account opens a Fidelity Youth Account for a teen. However, the teen owns and directs the money themselves. As a result, there is no custodian for this type of account. Adults can still monitor how children are using the money, but the children can invest and earn money themselves through a handy app. For example, children can complete challenges and refer friends to earn additional money. Additionally, teens can get a debit card through which they earn small amounts of money for each purchase.

With the money they deposit and earn, youth can save or invest in ETFs, mutual funds, individual stocks, and more. The app provides easy options for virtual trading and a range of investment vehicles. However, Fidelity does not allow youth to trade very risky investments.

There is an age restriction on this account. Specifically, teens must be a minimum age of 13 to have a Fidelity Youth Account.

High Yield Savings Accounts

A high-yield savings account (HYSA) offers higher interest rates than conventional savings accounts. For example, as of this writing (9/8/2023), HYSAs are offering interest rates of 4-5% while conventional savings accounts have interest rates that are 0.01%. So if you deposit $10,000 into a HYSA, you’d earn $400-$500 in a year. In contrast, if you deposited that money into a conventional savings account you’d earn *drumroll please* 1 whole dollar.

What’s the catch with these accounts? Honestly, there’s virtually no catch. HYSAs are generally offered by online banks that don’t have to pay for brick and mortar buildings and support. Consequently, if you really enjoy going into your bank and talking to a person, you won’t have much luck with many companies that offer HYSAs. But in this day and age, there aren’t many people who are too sad about having to deal with customer service via email, chat, or phone instead. Companies that offer HYSAs also don’t always offer ATMs. Other than those downsides, HYSAs are just as flexible as regular savings accounts. You can move money in and out as you please.

529 Plan

A 529 plan is a type of education savings account. As with custodial accounts, an adult open and controls a 529 plan on behalf of a beneficiary. However, at no point does it change ownership to a child. You can contribute as much as you’d like to a 529 plan and invest your savings in any of the investment vehicles (stocks, ETFs, mutual funds, bonds, etc.) mentioned above. Some accounts even automatically shift your investments to safer vehicles over time as your child gets closer to college age. Moreover, 529 plans are tax-advantaged in a similar way as Roth IRAs. Specifically, you contribute post-tax income, but then you don’t have to pay taxes on earnings from the account.

You can also withdraw funds without penalties if they are used for qualified educational expenses. These educational expenses can include college tuition, fees, books, college room and board, student loans, K-12 tuition, or expenses for accredited apprenticeship programs. If your child doesn’t go to college, you can change the beneficiary to a different individual (including yourself if you plan to get continuing education!) You can also withdraw the money penalty free if the beneficiary passes away, becomes disabled, attends a U.S. Military Academy, or receives a tax-free scholarship.

Final Thoughts

Custodial brokerage accounts are great options for building financial literacy in children. Furthermore, they can help set children up for a strong financial future, which makes adulting a heck of a lot easier. Perhaps even more importantly, they can be a tool for bonding, sharing knowledge, and learning together. As the Mastercard commercial used to say, “That’s priceless.”

However, remember that I am not a financial advisor. I cannot provide any financial advice, this content is purely for entertainment and educational purposes. Before many any financial decisions, speak with a professional.

If you like this post, please consider liking, subscribing, or sharing. It’s always a big help! And if you’re interested in related posts, check out my guides to teaching kids about money, investing for retirement, and how to get started investing.