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Investing in the financial markets is an activity that has been recently made available to the masses amid the introduction of zero-commission trading services and user-friendly platforms that allow individuals to build portfolios in a matter of minutes at a low cost.
Meanwhile, certain brokerage services have ‘gamified’ the trading and investing experience to attract the youngest cohort of Americans who are now becoming increasingly interested in getting exposure to the markets from an early age.
However, can you open an investment account if you are a teenager?
The following article shows you how to invest as a teenager in the financial markets by presenting you the types of accounts you can open along with a list of instruments and providers that are available to you to start your journey.
Why Start Investing As A Teenager
One of the world’s most successful investors — Warren Buffett — once cited what he called “the snowball effect” to explain why investing at an early age can increase the odds of becoming a wealthy adult.
This analogy refers to how a small snowball, referring to a small initial deposit, can become a big one as long as you let it roll down the hill for a long period. The longer it keeps rolling, the bigger it gets and this is the main reason why you should start investing in the markets even if you are just a teenager.
Imagine you open an account with just $500 when you are 12 years olds and invest that money in an index fund tracking the S&P 500. If you do that, by the time you are 35, you’ll have around $4,478 if the index behaves similarly as it had in the past 50 years or so.
Meanwhile, if you add money to the account every month — even just a tiny bit — that figure can grow even larger and you could end up having enough money for a down payment on a house if you are disciplined enough to let your money sit there for that long while reinvesting the proceeds you get in the form of dividends.
On the other hand, exposing yourself to the dynamics of the financial markets from a young age can also help you in understanding how economics work and how capital moves the world. This is a profound understanding that will help you in succeeding later on in life.
See Also: How to Buy Bitcoin: A Step-by-Step Guide
Requirements to Invest As A Teenager
If you are less than 18 years old, you should know that you are not legally permitted to open an account with an institution that offers access to the financial market by yourself. However, there are still ways to invest. Here’s how.
If you plan to trade securities such as stocks, exchange-traded funds (ETF), or bonds, you must open an account with a brokerage firm. Only individuals who are older than 18 years old are permitted to do so. Otherwise, if you are younger than that, you can ask your legal representative to open a custodial account for you.
These accounts allow you to place trade orders, build an investment portfolio, and many other features that are available for regular accounts.
To purchase any kind of real estate property, you will have to be 18 years old at least to be able to sign the required paperwork. The same goes in case you want to buy real estate investment trusts (REITs), which are available via a brokerage account.
If you would like to buy real estate, you may ask your legal representative to incorporate a trust that will contemplate the transfer of said property once you turn 18.
Best Investing Accounts for Teenagers
Not all investment accounts available for teenagers are created equal. Some of these accounts are opened for a specific purpose such as saving for college while others limit the type of instruments you can invest in.
Here’s a brief overview of the types of accounts available at the moment for teenagers in the United States.
✎ Editor’s Note
The best investing accounts for teenagers are simple and inexpensive. Make sure the account has no minimum deposit or balance to maintain and that allows you to set up automatic investment.
Custodial IRA Accounts
An individual retirement account (IRA) is a tax-advantaged type of account that defers the payment of taxes for the beneficiary until the money is withdrawn. Here we explain how these accounts work if you are a teenager.
Custodial Traditional IRA
A traditional custodial IRA is a great alternative for parents who would like to help their children in saving for retirement from an early age. The most prominent benefit of these accounts is that the impact of compounding is more powerful as money can be reinvested for many more years than usual.
Any income produced by the assets held within the account is not taxable unless the money is withdrawn before the retirement age, in which case the holder has to pay a 10% penalty.
In 2022, the maximum contribution for a traditional custodial IRA is $6,000 per child per year. This money can be invested in a wide range of financial instruments including stocks, bonds, exchange-traded funds (ETFs), and mutual funds.
One added benefit of these accounts is that the law permits a penalty-free withdrawal for buying the holder’s first home.
Custodial Roth IRA
Roth IRAs serve a similar purpose, which is to save and invest money in building a retirement fund for children at an early age. However, one of the key differences between these accounts and traditional ones is that contributions are not tax-deductible for parents.
Same as traditional IRAs, the maximum contribution for Roth IRAs stands at $6,000 per child per year as of 2022.
The benefit of this account is that the total amount of contributions deposited into the account can be withdrawn after five years have passed without having to pay an early withdrawal penalty or any income tax as this levy has already been paid.
The assets held within these accounts are considered part of the kid’s net worth and they must be transferred to them once they have reached the age of majority, which is typically between 18 and 21 years old depending on the state.
A 529 Education Savings Plan
A 529 account is specifically intended to finance a child’s college tuition and college-related expenses and parents can use it as a tax-advantaged vehicle to save money for this stage of their kid’s life.
These accounts allow the beneficiary to either purchase units of credit at participating colleges and can also be used as an education savings plan. This latter option is the most popular and it involves investing the contributions made to the account into different financial instruments including mutual funds and exchange-traded funds (ETF).
Meanwhile, since the money is intended to be used to pay for the kid’s college expenses, withdrawals are typically limited and can only be made for this purpose or else a penalty and corresponding taxes will have to be paid.
Meanwhile, as long as the money remains in the account, no taxes have to be paid on the earnings the investments generate. Finally, parents can contribute as much as $75,000 per year ($150,000 for married couples) to a 529 account.
IRA Accounts (Custodial Traditional IRA & Custodial Roth IRA)
A custodial individual retirement (IRA) and custodial Roth IRA accounts are tax-advantaged accounts that parents can open for their kids to help them save for retirement from an early age.
These accounts work similarly to a traditional IRA opened by an adult, with the added benefit that due to the longer investment horizon the impact of compounding will be larger and could possibly increase the net amount saved once the kid reaches retirement age.
Similar to regular retirement accounts, early withdrawals are subject to penalties and taxes unless they are made to pay for educational expenditures. Moreover, the assets held within the account are considered part of the kid’s net worth and they must be transferred to them once they reach the age of majority, which is typically between 18 and 21 years old depending on the state.
Coverdell Education Savings Accounts (ESA)
A Coverdell account is another way of saving for college through a tax-advantaged account, although the specifics of how this account works are a bit different from other alternatives such as 529s.
For one, there is a contribution limit of $2,000 per year per contributor. That said, parents can apply for “superfunding” through Form 709 to be able to contribute up to five years in contributions while avoiding gift taxes.
On the other hand, parents with a net combined income that exceeds $220,000 are not eligible for this type of account.
Meanwhile, the investment options are ample with a Coverdell compared to a 529, as the funds held within the latter can only be invested in state-sponsored plans and a small selection of approved instruments.
One benefit of Coverdell accounts is that they are more flexible when it comes to withdrawals as parents can opt to use the funds to pay for non-tuition qualified expenses including books, supplies, uniforms, etc. These withdrawals apply not just to college expenses but also elementary and secondary school.
✎ Editor’s Note
Keep in mind that the money you hold in a Coverdell account can be used to pay for a number of expenses for kids attending primary, secondary, and higher education schools.
Best Investment Options For Teenagers
From index funds to bonds and micro-investing apps, there are plenty of options for teenagers to start investing in the markets.
Certificates of Deposit (CDs)
A certificate of deposit (CD) is a financial instrument issued by a bank or a financial services firm that entitles the holder to receive a set of periodical interest payments in exchange for locking up a certain amount of money for a pre-determined period.
CDs are popular because they are considered as safe as a traditional savings account. In fact, they are protected by the FDIC in the same way as the latter.
CDs are typically structured in a way that interest payments are reinvested into the instrument. This has the added advantage of compounding, which consists of increasing returns by reinvesting the proceeds obtained from the investment.
Index funds are financial instruments that track the performance of a certain broad-market index such as the S&P 500 or the Dow Jones Industrial Average or sector-specific or foreign indexes.
Index funds are often viewed as the best alternative to build passively-managed portfolios as the historical performance of these benchmarks has been quite satisfactory while the volatility of these results is typically reduced during long holding periods.
Moreover, the cost of holding index funds is typically low and some providers even offer no-load alternatives that reduce those fees to zero.
An exchange-traded fund (ETF) works similarly to a mutual fund but with the added advantage that the instrument can be easily bought and sold as if it were a stock with zero penalties or costs involved in the process.
Meanwhile, most providers nowadays offer the possibility of trading ETFs for free. However, these funds usually charge an annual expense expressed as a percentage of the amount invested.
Through ETFs, investors can get exposure to a wide variety of asset classes, markets, geographies, and industries and that makes them a great choice for building a diversified investment portfolio for your custodial account.
See Also: What is Micro Investing? Is It the Best Way to Start Investing?
A mutual fund is a vehicle that invests in different asset classes following a pre-defined scope and strategy and they are managed by investment professionals and offered by well-reputed institutions including bank and financial services companies.
The main difference between mutual funds and ETFs is their liquidity, as mutual funds often impose limitations in the minimum holding period required before a withdrawal can be made.
Nowadays, amid the rise of low-cost ETFs, mutual funds have been forced to slash their expense ratios, management fees, and other related costs to keep attracting investors.
Some of the asset classes covered by mutual funds include fixed-income securities, equities, precious metals, and active strategies that focus on certain types of companies or sectors of the economy.
A stock is a financial instrument that gives the holder ownership over a certain percentage of a company’s assets. They are considered a variable-income asset class as the largest portion of the returns obtained come in the form of price appreciation — known as capital gains.
That said, certain companies also issue dividends, which are fixed payments distributed to shareholders based on the percentage of the company they own.
On the other hand, by owning a stock, a holder can vote on crucial decisions about the company’s future by exercising his/her voting rights during the annual shareholders’ meeting.
Bonds are a fixed-income security that entitles the holder to receive a periodical interest payment in compensation for extending a loan to the issuer. The interest rate paid by the issuer varies depending on its creditworthiness while bonds can have different maturities.
Based on their maturity dates, bonds can be classified as short-term, mid-term, or long-term and depending on the nature of the issuer they are typically classified as government, municipal, corporate, sovereign, and GSE bonds.
Also, some bonds do not pay an interest rate and these are known as zero-coupon bonds. Those who buy this type of bond are allowed to buy the issue at a discounted price below their par value — the nominal value of the bond – to benefit from the spread between the par value and the purchase price once the bond matures.
High-Yield Savings Account
A savings account is an instrument offered by a financial institution that is typically considered the safest investment alternative as they are protected by the Federal Deposit Insurance Corporation (FDIC).
Although most savings accounts nowadays offer a low yield due to the current interest rate environment, there are still certain providers that offer high-yield savings instruments.
With a savings account, the holder is entitled to receive a periodical interest payment — typically monthly — that is calculated based on the average daily or monthly closing balance held within the account.
Account holders can choose to either maintain that interest within the account to enjoy the benefits of compounding or they can withdraw it at any given point in time.
See Also: 12 Best Investment Apps
Tips For Investing As A Teenager
There is so much information about the financial markets and the different instruments that are available to investors that it might be easy to feel overwhelmed if this is the first time you are approaching the subject.
With this in mind, this section shares some useful recommendations that may help you if you are just starting out in the investment world.
Consider Paper Trading
Paper trading involves using a demo account provided by an actual broker that comes loaded with a sizable amount of money so beginner investors and traders can test the waters of the financial markets before they commit any money to this activity.
Paper trading can be used for multiple purposes such as testing a new trading system, researching and learning how the broker’s trading platform works, or just giving it your first shot at buying and selling securities.
Get Advice From Professionals
If you are new to the markets, you should seek guidance at first to avoid making costly mistakes that could otherwise be avoided with the help of an experienced third party. Nowadays, financial advice comes in many forms. For example, you could hire a financial planner who can outline a step-by-step program to reach your financial goals.
On the other hand, you may also opt to hire a human advisor to build a customized investment portfolio or rely on the services of a robo-advisor, which is an automated passive investing solution that can build a portfolio on your behalf after you provide some basic information about your financial goals, risk tolerance, income, and employment (if any).
Invest For The Long Term
Have you ever heard about the snowball effect? This illustration can be extrapolated to investments as you can start building a portfolio with a small amount of money that will progressively grow as you reinvest all the proceeds you earn in the form of dividends, interest, or capital gains.
The earlier you start, the lengthier the slope will be, meaning that money will have more time to compound. Even if the snowball is small in the beginning, the financial markets can work on your behalf if you stay the course for a long time.
This involves buying and holding your investments for longer than 3 years. As the adage goes, “time in the market beats timing the market”. The best way to avoid gambling and guessing is to buy both the lows and the highs by following time-tested methodologies such as dollar-cost averaging (DCA).
Have some patience, stick to your system, and keep adding money to your account progressively and that snowball will ultimately grow to the size of an avalanche.
Use Micro Savings Apps
Financial technology companies nowadays have launched multiple micro-investing and savings products that allow retail investors to progressively build emergency funds or even a retirement account by automatically transferring the spare change left when an expense is made or via stock-based rewards.
One of these companies is Acorns, an automated passive investing platform that is considered a one-stop-shop for all things money management as investors can open savings, retirement, and taxable investment accounts with this provider to fully enjoy their multiple services in exchange for a monthly subscription fee.
By using fractional shares, Acorns allows investors to buy fractions of a stock with as little as $1 to progressively build their investment portfolios without the need for a big initial deposit.
Consider Fractional Share Investing
Fractional shares are a low-cost alternative for investors who lack a large account balance, allowing them to build a broadly diversified portfolio of multiple stocks and ETFs with as little as $1 per instrument.
Public.com is one of those providers currently offering these innovative instruments, while the company has also created a social investing ecosystem through which investors can exchange ideas, chat, and enrich each other by sharing insightful opinions and analysis about the stocks and ETFs they are currently investing in.
Public does not charge any commissions for trading these instruments and that makes it a great alternative for teenagers who might be seeking to build an investment portfolio from scratch.
Use A Robo-Advisor
A robo-advisor is a system that relies on algorithms to build broadly diversified investment portfolios for investors based on their financial goals, risk tolerance, income, employment situation, and other factors, effectively relieving them from of burden of having to do all the heavy lifting.
Many brokerage firms have introduced robo-advisors to their portfolio of investment solutions, using low-cost exchange-traded funds (ETF) to build these portfolios in a matter of minutes while charging relatively low fees to perform the service.
If you are a teenager who doesn’t know much about investing, companies like Betterment offer these “portfolio in auto-pilot” solutions that you can rely on to deposit the money you have received from your parents and relatives for your college education and future.
FAQ Investing As A Teenager
We’ve found some of the most frequently asked questions regarding investing as a teenager, here are our answers.
How Old Do You Have to Be to Invest in Stocks?
When you are a teenager, you can’t just go to a brokerage firm and open an account by yourself because the law states that you must be at least 18 years old to do that. However, your parents can open an account for you and act as custodians of that account.
Now, can you make decisions in regards to the investments you want to make even if your parents opened the account?
Sure. You can talk to your parents and negotiate an arrangement in which they let you manage the money they have deposited into the account and you can use the online trading platform provided by your brokerage firm to execute these transactions.
As long as you have their permission, you can manage the money held within the account to learn the dynamics of stock investing and trading.
How Do Taxes Work for Teen Investors?
Although most of the accounts currently offered to teenagers are tax-deferred, you should know that, in case you withdraw money from it, you will probably have to pay taxes on the proceeds you obtain from your investments.
That said, the rate that applies to teenagers for the first $2,200 in unearned income is lower than that for adults and this rate is known as the “kiddie tax”, which applies to individuals under 19 years old or to full-time students whose age is between 19 to 23.
For the first $1,100 of unearned income, the marginal income tax rate applies, while the next $1,100 will be taxed at the ‘kiddie’ rate, which can be as low as 0% in some cases. Any subsequent contributions are taxed at the regular income tax rate applicable to the parent or guardian.
How Do Taxes Work For Custodial Accounts?
Custodial accounts are taxed differently than traditional accounts. Any income generated by the assets held within the account is taxed at the child’s tax rate once he turns 18 years old. As of 2022, up to $1,150 in earnings per year will be tax-exempt. Meanwhile, if earnings exceed $2,300, the proceeds will be taxed at the parent’s tax rate.
What Happens to Custodial Account When a Kid Turns 18?
Once the beneficiary turns 18, he will be granted access and full control over the assets held within the custodial account. Meanwhile, the custodian’s access to the account will be restricted unless the child indicates otherwise.
Starting your investing journey at an early age will allow you to compound your earnings for a longer period and this will have a dramatic impact on your net worth once you are an adult.
Even though some of the accounts offered for teenagers nowadays focus mostly on saving or investing to pay for your college expenditures, others can be used as a vehicle to just build wealth.
Don’t underestimate the power and freedom that wealth can give you to make decisions about what kind of career you would like to pursue or which job you decide to apply for as having a nest egg can reduce the pressure of having to make decisions based solely on your financial needs so you can instead pursuit what you are most passionate about without having to worry that much about money.
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Alejandro is a financial writer with 7 years of experience in financial management and financial analysis. He writes technical content about economics, finance, investments, and real estate and has also assisted financial businesses in building their digital marketing strategy. His favorite topics are value investing and financial analysis.