How to Invest as a Kid: A Parent’s Primer

Investing for children provides a valuable opportunity to cultivate financial literacy and establish a foundation for their future. Introducing investment concepts early helps young individuals understand how money can grow, preparing them for financial independence. This guide outlines various investment avenues and practical steps for parents to consider.

Investment Accounts for Minors

Several types of investment accounts exist for minors, each with distinct features regarding management, asset ownership, and tax implications. Understanding these differences helps parents choose an account that aligns with their child’s financial goals.

One common option is a custodial account, established under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). An adult custodian, typically a parent or guardian, manages the assets, but they legally belong to the minor. Contributions to these accounts are irrevocable gifts. The minor gains full control upon reaching the age of majority, typically 18 or 21, which can vary by state.

Investment income generated within UGMA/UTMA accounts may be subject to the “kiddie tax.” For tax purposes, the first $1,350 of a child’s unearned income is tax-free. The next $1,350 is taxed at the child’s rate, while income exceeding $2,700 is taxed at the parent’s marginal rate. This tax structure aims to prevent higher-income individuals from shifting investment income to avoid higher tax brackets.

Another option is a Custodial Roth IRA, designed for minors with earned income from employment. An adult custodian manages this retirement account until the minor reaches the age of majority. Contributions are made with after-tax dollars, allowing for tax-free growth and qualified tax-free withdrawals in retirement.

The annual contribution limit for a Custodial Roth IRA is the lesser of the minor’s earned income or a specified maximum ($7,000 for 2025). This account offers substantial long-term tax advantages, particularly as most minors are in a low tax bracket. While retirement-focused, contributions can be withdrawn tax-free and penalty-free at any time. Earnings can also be withdrawn for specific qualified purposes, such as a first-time home purchase or qualified education expenses, under certain conditions.

For those just beginning to save, a basic savings account provides a simple starting point. These accounts are easily accessible and do not require earned income. They serve as a fundamental tool for teaching children about saving money, though their growth potential is much lower compared to investment accounts.

Setting Up an Investment Account

Establishing an investment account for a minor involves several steps, beginning with selecting a suitable brokerage firm. Parents should evaluate factors like fee structure and minimum investment requirements. Many online brokerage firms offer zero-commission trading for stocks and ETFs, and some have no minimum deposit for custodial accounts. However, certain investments within these accounts might still carry their own fees or minimums.

Once a brokerage firm is selected, the next step involves gathering necessary documentation. To open a custodial account, parents or guardians need to provide government-issued identification, such as a driver’s license, along with the child’s Social Security Number. Bank account details for funding the new investment account will also be required.

The application process can often be completed online. This process involves providing personal information for both the custodian and the minor, selecting the account type (e.g., UGMA/UTMA or Custodial Roth IRA), and linking a funding source. The application will also require acknowledging the terms and conditions of the custodial arrangement.

After the application is approved, the final step is initial funding. This can be done through an electronic funds transfer from a linked bank account, a check deposit, or by transferring existing assets. Some firms may offer recurring deposit options, which can help establish consistent saving habits.

Investment Options for Kids

Once an investment account is established, parents can explore various investment options suitable for long-term growth within a child’s portfolio. Each type carries different characteristics and potential returns.

Stocks represent fractional ownership in a company. If the company performs well, the value of shares can increase over time, offering capital appreciation. Some companies also distribute profits to shareholders as dividends. However, stock prices can fluctuate based on market conditions and company performance.

Exchange-Traded Funds (ETFs) are collections of stocks, bonds, or other assets that trade like individual stocks. ETFs offer diversification by allowing investors to own a basket of securities with a single purchase, which can help reduce the risk of investing in individual companies. They are known for their lower costs compared to actively managed funds and provide transparency as their holdings are often disclosed daily.

Mutual funds also pool money from many investors to buy a diversified portfolio of stocks, bonds, or other investments. These funds are professionally managed, with fund managers making investment decisions based on the fund’s stated objectives. Mutual funds offer diversification and professional oversight, which can be beneficial for those who prefer not to manage individual securities. Unlike ETFs, mutual fund shares are priced once daily after the market closes.

Savings bonds, issued by the government, offer a low-risk and secure investment option. They provide a guaranteed return over a set period and are seen as a safe haven for preserving capital. While they offer security, their growth potential is more modest compared to equity investments.

Building Investment Habits

Cultivating positive investment habits from a young age can significantly influence a child’s financial future. One fundamental practice is making regular contributions to their investment accounts. Consistent, even small, contributions over time can accumulate substantial wealth due to compounding.

Compounding refers to the process where investment earnings generate their own earnings. This “snowball effect” means that money grows not only from the initial amount invested but also from accumulated interest or returns. Starting early allows more time for compounding to work, amplifying investment growth over many years.

Maintaining a long-term perspective is important when investing for children. Investment values can fluctuate in the short term, but focusing on long-term growth helps families remain patient through market ups and downs. This approach aligns with the extended time horizon available for a child’s investments, which can span decades.

Involving the child in the investment process, in age-appropriate ways, can reinforce these habits. This includes discussing financial goals, reviewing investment statements to observe growth, or teaching them about budgeting and the difference between needs and wants. Engaging children helps them understand the practical implications of saving and investing, fostering ownership over their financial journey.