What Should You Invest in as a Teenager?

Investing involves allocating money with the expectation of generating a profit or increasing its value over time. It differs from saving, which typically focuses on preserving capital, by taking on some level of risk in pursuit of growth. For teenagers, understanding and engaging in investing establishes a foundation for long-term financial stability. Starting this journey early offers a significant advantage, allowing for a longer period during which investments can grow. This benefit is largely due to the concept of compounding, where initial investments and the returns they generate earn further returns. This extended timeframe can lead to wealth accumulation difficult to achieve by starting later. Early exposure also fosters positive financial habits, such as disciplined saving and strategic planning.

Foundational Investment Concepts

A core principle of investing is compounding, where earnings are reinvested to generate their own earnings. This means money grows faster over time, especially across extended periods. For example, if an account earns interest, the next period’s interest is calculated on the original amount plus accumulated interest.

Diversification involves spreading investments across various assets, industries, and geographical regions. This strategy reduces overall risk within a portfolio. By not concentrating funds into a single investment, the negative performance of one asset can be offset by others. Diversification helps stabilize returns and mitigate market volatility.

The relationship between risk and return is also fundamental. Investments with higher potential returns often carry higher risk. Conversely, lower-risk investments typically offer more modest returns. Teenagers, with a longer investment horizon, can consider taking on calculated risk, as they have more time for investments to recover from downturns and benefit from long-term growth.

Investment Accounts for Young Investors

Teenagers cannot independently open standard brokerage accounts until they reach the age of majority, typically 18. However, several account types allow minors to begin investing with adult supervision. These accounts provide distinct benefits and adhere to specific regulations, including varying tax implications.

Custodial Accounts (UGMA/UTMA)

Custodial Accounts, established under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), are managed by an adult custodian, usually a parent or guardian. The minor gains full control of the assets upon reaching the age of majority (between 18 and 21, depending on the state). Assets are legally owned by the minor, but the custodian makes all investment decisions until the minor comes of age. Taxation for UGMA/UTMA accounts can involve “kiddie tax” rules, which apply to unearned income above a certain threshold. This means that income above a certain amount may be taxed at the parent’s marginal tax rate rather than the child’s lower rate. This prevents parents from shifting assets to children solely to avoid higher taxes.

Roth Individual Retirement Account (IRA)

A Roth IRA is another option for minors with earned income. Unlike custodial accounts, a Roth IRA requires the minor to have taxable compensation, such as wages from a job, to contribute. Contributions cannot exceed the minor’s earned income for the year or the annual contribution limit. Contributions are made with after-tax dollars, meaning the money grows tax-free, and qualified withdrawals in retirement are also tax-free. Earnings and qualified distributions are not subject to federal income tax in retirement. While contributions can be withdrawn tax-free and penalty-free at any time, earnings typically require the account to be open for five years and the account holder to be at least 59½ years old for qualified tax-free withdrawals. An exception allows withdrawals for a first-time home purchase. This combination of tax-free growth and tax-free withdrawals makes a Roth IRA effective for long-term wealth building, especially for young investors.

Investment Choices for Teenagers

Once an investment account is established, selecting suitable investment vehicles is the next step. For young investors with a long-term horizon, growth-oriented options that offer diversification are often recommended. These choices can be held within custodial accounts or Roth IRAs.

Stocks

Stocks represent ownership shares in a company. If the company performs well, its stock value may increase, offering potential capital gains. Stocks can provide growth potential, but their values can fluctuate significantly, reflecting company performance and market conditions.

Exchange-Traded Funds (ETFs)

ETFs offer a way to invest in a collection of assets, such as many stocks, with a single purchase. ETFs track an index, commodity, bonds, or a basket of assets, providing instant diversification. They trade on stock exchanges throughout the day, similar to individual stocks, and are known for their relatively low expense ratios. This makes them accessible for beginners seeking broad market exposure.

Mutual Funds

Mutual Funds pool money from many investors to purchase a diversified portfolio of stocks, bonds, or other securities. These funds are professionally managed, with fund managers making investment decisions. Like ETFs, mutual funds offer diversification, spreading investment risk across numerous holdings. They are priced once per day after the market closes.

Index Funds

Within both ETFs and mutual funds, low-cost index funds are a popular choice, particularly for new investors. Index funds aim to replicate the performance of a specific market index, such as the S&P 500, rather than trying to outperform the market. Their passive management style typically results in lower fees compared to actively managed funds. This combination of broad market exposure, diversification, and low costs makes index funds an efficient way to participate in the growth of the overall market.

Steps to Begin Investing

Starting to invest as a teenager involves a few clear steps, typically requiring collaboration with a parent or guardian. This process ensures compliance with legal requirements and provides guidance for informed financial decisions.

Choose an Investment Firm

First, choose an investment firm, often called a brokerage. Many online brokerages offer custodial accounts and Roth IRAs for minors. When selecting a firm, consider user-friendly platforms, educational resources, and competitive fees. A parent or guardian will usually initiate this process, as they will be the custodian or primary account holder until the minor reaches legal age.

Open the Account

Next, the account needs to be officially opened. For a custodial account or Roth IRA for a minor, a parent or legal guardian will complete the application. This process typically requires personal information for both the minor and the custodian, including Social Security numbers, dates of birth, and contact details. The brokerage firm will also require identity verification for the adults involved.

Fund the Account

Once the account is open, fund it. Money can be transferred through various methods, such as electronic transfers from a linked bank account, direct deposits, or checks. Many brokerages allow for automated recurring transfers, which helps establish a consistent investing habit. Regular contributions, even small ones, can benefit from compounding over time.

Purchase Investments

With the account funded, investments can be purchased. Log into the brokerage platform and search for specific investment products, such as stocks by their ticker symbol, or particular ETFs and mutual funds. The platform guides users through specifying the amount to invest and executing the trade. For minors, the custodian typically places these trades.

Monitor and Learn

Finally, regularly monitor investments and continue to learn about financial markets. While frequent trading is not recommended for long-term investors, periodically reviewing account statements and understanding investment performance can be valuable. Many brokerage firms offer educational materials and tools to help teenagers and their custodians deepen their financial knowledge.