Investing > Stocks/Bonds

Cents-Smart Investing
NEALE S. GODFREY. Associated Press.
Copyright Associated Press

Do it while young

The smartest investment rule to teach your teen is simply this: Start young. Investing when he's young will give him a much greater return. If he doesn't start investing until he is older, his money simply is not going to do the same work for him.

FACT: If your child invests $2,000 a year (or $40 a week) for 10 years at a 10 percent rate of return, starting when he's 21 and stopping when he's 30, that $200,000 investment will have grown to over $985,000 by the time he reaches 65.

FACT: If he waits until he is 31, and invests the same $2,000 a year for 10 years at a 10 percent rate of return, his $20,000 investment will be worth $400,000 when he reaches 65. An investment strategy

An investment strategy is based on two principles. First, and I'll say it again because it's important: The more money your teen is able to put to work for himself when he's young, the more it will be worth when he's older. Second, the basic strategy of investing is to have your young investor balance out his financial resources over time, so he's putting money aside when he can most afford to and then will have the maximum amount of money available when he most needs it. Three key words: "liquidity," "risk" and "diversification"

Liquidity: The liquidity of an investment pertains to how quickly it can be converted into cash. The more liquid the investment is, the easier it is to convert (cash itself is totally liquid). Generally speaking, the more return a particular type of investment can generate, the less liquid it is likely to be.

Explain to your teen that if he's investing money he's earning after school and saving for his first car, which he wants to buy when he turns 18 in six months, he'll want to put his money into a liquid investment such as a money market fund. If he's saving for a car that he'll buy in five years when he graduates from college, he can invest in something less liquid, such as stocks or a five-year CD.

Risk: Risk is just what the term suggests. Some investments are incredibly safe. A safe investment means that it's extremely likely that your teen will make some money and that he won't lose any. Other investments are riskier, and the chances that the investment won't do well are higher. As your teen might expect, the least risky investments are the ones that carry the smallest return; the riskiest ones give you the possibility of much higher rates of return.

Explain to your teen that there's no such thing as a free lunch. If the investment looks too good to be true, it probably is. But there is such a thing as acceptable risk, and the amount of risk an investor considers acceptable changes according to his circumstances.

For example, over the past 70 years, risk-free investments such as Treasury bills have returned an average of less than 4 percent per year. During the same period, the shares of large blue-chip companies have returned an average of 10.3 percent a year and stocks of smaller companies had an average return of 12.3 percent per year.

Diversification: The third key word in formuating an investment strategy is "diversification," also known as not putting all your eggs in one basket. Your teen has to learn to make sure his investments fit his particular timetable. For example, if money - cash - is going to be needed, then his investments should allow access to it. If he invests all his money so that he can't get it when he will need it, he has a problem. The diversification of his investments should reflect his needs. Never too young

As you start to teach your teen the financial facts of investing, the one piece of advice to impart is this: When he gets his first real job and he's all caught up in "take-home pay," tell him to also concentrate on enrolling in his employer's 401k plan, or to set up his own individual retirement account (IRA).

Seems crazy to talk to your teen about retirement planning? Remember that, the younger he is when he starts investing, the more his money will grow. If he has a job now, he can start an IRA. Explain to your teen how IRAs work. The government gives you a tax break on $2,000 a year. Big deal! Only $2,000 a year? Well, look at it this way. Suppose he simply takes the $2,000 and invests it at 8.5 percent. If he uses after-tax dollars to fund this account each year (and figuring, for the sake of argument, that he's paying 28 percent income tax on interest), his savings will grow to $118,431 in 25 years.

That, as they say, ain't hay. But if he takes the same $2,000 a year and sets up an IRA, he's using pretax dollars, his taxable income is lower, he doesn't have to pay taxes on the interest each year and, by the end of the same 25 years, he'll have $170,709.

That's $52,278 more. And that REALLY ain't hay.

The point is, in order for any of life's lessons to stick, you have to teach the lessons early. Can you imagine where you'd be today if your parents had spoken to you about investing when you were a teen-ager? Vocabulary

When your teen gets into the world of investing, he will increase his vocabulary. Here are definitions for some frequently used words and terms:

Leverage - Using borrowed money to buy something.

Stocks - The way an investor buys part of a company. Stocks can be traded among investors which is how their prices go higher or lower.

Face Value - How much a bond is worth when it comes time for the company or government that issued it to pay the investor.

Prospectus - A company's formal offering of stock, bonds or other securities that gives investors information about the company's prospects. Also, a document all mutual funds must prepare that describes what they invest in and how they do business.

Mutual Funds - A pool of money that invests in many companies, allowing investors to spread small amounts of money across many securities.

Dollar Cost Averaging - A way to make money by investing a small amount every week or every month in the stock market or in mutual funds.

Diversification - Buying different types of investments - some stocks, some bonds, some mutual funds - in order to reduce your chance of losing money. If stock prices go down, bond prices may go up, and you won't lose money.

Bonds - An IOU from a company or a government. You give the company or government some money and they promise to pay you, over time, the amount plus a little bit more. The little bit more is called the interest rate.

Laddering - A plan to buy bonds that are paid back over several different time periods. So, instead of buying one $10,000 bond that will be paid off in 10 years, you might buy five $2,000 bonds that will be paid off in two, four, six, eight and 10 years. This protects you from big changes in interest rates.

Load - The fee you pay to buy shares of some mutual funds. It's also called a sales charge. Many mutual funds do not charge these fees. They're called no-load mutual funds


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