Investing Your Money As A Teenager: What You Should Know
Do you want to become wealthy? Start investing when you are young. No, seriously – if you contribute the maximum amount to your Roth IRA from the ages of 15 to 20, and never make another investment, you’ll have more than $2.7 million by the time you attain the age of 65, assuming a historically average 10 percent return on the stock market.
Don’t be scared by the voluminous amount of financial jargon. You don’t have to become a personal finance whiz to be successful. To accumulate wealth, all you need to do is grasp a few fundamental concepts and make consistent monthly investments.
An overview of the account types that are best suited for teenagers
The majority of financial accounts are not very important to teenagers. Moreover, if you are a young adult, you should be familiar with a few different types of accounts in particular.
1. Brokerage Account That Is Taxable
A taxable brokerage account is what you may call your standard vanilla investment account because it allows you to invest money without benefiting from any particular tax savings. It takes fewer than five minutes to open an account with a reputable novice investment broker such as Vanguard, TD Ameritrade, or Charles Schwab online.
The accounts can be used to buy and sell socks, bonds, real estate investment trusts (REITs), exchange-traded funds (ETFs), commodities, and other publicly-traded assets once they have been opened. In a moment, I’ll talk about the best of these investments for teenagers.
And, no, you are not required to pick and choose the investments you want to make yourself. Sign up with a financial institution that provides a free robo-advisor service, and they will select and handle the best assets for you on your behalf.
2. Traditional and Roth IRAs
Apart from traditional and Roth Individual Retirement Accounts (IRAs), investment brokerages also provide tax-sheltered individual retirement accounts (IRAs) in addition to their standard taxable accounts.
These are available in two different flavors. Traditional IRAs allow you to deduct your contribution from your taxable income on your tax return for the current tax year. Roth IRAs, on the other hand, do not provide you with immediate tax savings, but the money grows and compounds tax-free, and you pay no taxes on withdrawals during your retirement years.
Investment in a Roth IRA makes lot more sense for youngsters who don’t bring home large paychecks but will be far wealthier in retirement than they are today. It will be considerably more valuable in the long run to let your savings and assets to grow tax-free for several decades than any little tax cut you could receive now on the income that most teenagers earn.
The process of opening and investing in Roth IRAs is identical to that of opening and investing in taxable investment accounts, and you use the same login at your investment brokerage.
3. Accounts in Custody (UGMA/UTMA)
If your parents or other family members opened a custodial account for you while you were a minor, you will normally be able to access it once you reach the age of majority (often 18).
These are also investment accounts that are managed by a brokerage company. You can access and manage your investments in the same way that you do with taxable accounts and IRAs.
Just keep in mind that these can have an influence on your financial aid applications and must be mentioned when completing your FAFSA application.
4. Coverdell Education Savings Account (Coverdell ESA) (ESA)
If you’re working during your adolescence in order to save money for college, consider putting the money into a Coverdell education savings account to maximize your returns (ESA).
These accounts operate in a similar way to Roth IRAs in that you do not receive an immediate tax deduction, but the money grows tax-free and you do not pay taxes when you removed the money to pay for qualified school expenditures such as tuition, fees, and books when you do so.
You can open these accounts through your investment brokerage firm once more.
5. Savings account with a high rate of return
Sometimes all you need is a safe place to stash your cash, with the understanding that you may need to access it within the next few months.
If you don’t want to risk your money by investing it and maybe losing it due to short-term volatility in the stock market, put it in a high-yield savings account. Because bank accounts are backed by the Federal Deposit Insurance Corporation (FDIC), you can reduce inflationary losses without taking any risks.
Optionally, you can keep your money in your checking account, but don’t expect to earn any interest on it any time soon.
Investing Your Money as a Teenager: What You Should Know
When it comes to accumulating wealth, teenagers have a significant edge over the rest of the population: they have more time for their assets to compound.
It is not necessary to be concerned about stock market volatility or the performance of your other investments unless you are investing for forthcoming college tuition. You have plenty of time until you need to start withdrawing money from your investments to fund your retirement or other long-term financial goals.
This means that you can invest aggressively in order to maximize your rewards. Allow older folks to be concerned about every dip and stock market correction; for you, they just represent an opportunity to purchase stocks “on sale.”
The following are the most popular types of assets in which you might consider making an investment.
1. Stocks are a good example of this.
If you make no other form of investment as a teenager, stock market investments are the best option.
Since its inception, the S&P 500 has generated an average annual return of almost ten percent on an annualized basis. Having your brokerage account (preferably a Roth IRA) set up in a matter of minutes will allow you to begin investing in stocks with a minimum investment of just $10.
Stocks also make it simple to diversify one’s investment portfolio. With a single click, you can purchase a diverse portfolio of stocks from the United States and around the world, including small and large companies and stocks from a variety of industries ranging from health care to technology to banking and beyond.
Moreover, using ETFs and mutual funds, you can achieve that diversification by investing in only one or two funds (more on these next).
2. Exchange-Traded Funds (ETFs) (ETFs)
An exchange-traded fund (ETF) is a type of mutual fund that invests in a variety of different equities. It’s also possible to invest in a variety of bonds or REITs, as well as precious metals, commodities, or any combination of the aforementioned assets.
For example, you can invest in an exchange-traded fund (ETF) that mirrors a stock market index such as the S&P 500. This type of “index fund” invests in all of the companies represented in a certain stock index, so owning a single share of the fund provides you ownership in every company included in the index.
In order to determine your optimum investment portfolio, robo-advisors inquire about your financial situation when you open an account with them (called your asset allocation). In most cases, if you agree their suggested portfolio, they will automatically distribute your money among the ETFs to ensure the greatest possible diversification and returns for you.
3. Mutual funds (sometimes known as mutual funds of funds)
Mutual funds, like exchange-traded funds (ETFs), invest in a diverse range of equities and other assets.
However, as their name implies, exchange-traded funds (ETFs) trade in real time on stock exchanges. Their stock prices fluctuate up and down throughout the day, depending on how much money investors are ready to pay for their shares.
Mutual funds, as opposed to exchange-traded funds (ETFs), have their values reset at the end of each day and are typically more actively managed by a fund management. As a result, they are generally more expensive as a general rule, as the fund itself charges higher fees each year.
Stick with passively managed exchange-traded funds (ETFs) as a teenager unless you have a strong reason to invest in a specific mutual fund.
4. The Real Estate Industry
As a teenager, you most likely don’t have the time, money, or expertise to make direct real estate investment decisions. Many elderly folks do not believe this as well. However, this does not rule out the possibility of making a real estate investment.
There are several ways to invest in real estate, ranging from real estate investment trusts (REITs) to real estate crowdfunding platforms and everything in between. With each one, you can create a new source of passive income for yourself. Consider Fundrise and Groundfloor as excellent entry-level investment possibilities that demand only modest initial investments to become involved.
Real estate has a number of advantages and disadvantages that are distinct from those of stocks. In many ways, their strengths and limitations are great complements to one another, which is why I invest for the long term in both equities and real estate.
5. Bonds are a fifth option.
Bonds are a foundation of retirees’ portfolios because of their steadiness, but you don’t need bonds in your portfolio as a teenager because they aren’t necessary.
Interest rates have maintained at historically low levels throughout the twenty-first century. Which means that bond investments, which offer lower returns while also presenting lower dangers, are best suited to retired individuals rather than young people who can tolerate larger risks in exchange for higher returns.
6. Apps for micro-investing are number six.
Micro-investing apps, while not necessarily an investment in and of themselves, provide a simple way to automate your savings and investment activities.
They all operate in a somewhat different way, but they all function in the same way: when you spend money, they round up to the nearest dollar and invest the difference in the market. So, for example, if you spend $12.50 on lunch out, they will round up the bill to $13 and deposit $.50 into your savings or investment account instead.
In many cases, these platforms function as Robo-advisors, automatically investing your money in a variety of ETFs on your behalf. Acorns is a simple and respectable alternative to consider.
Frequently Asked Questions about Investing as a Teenager
When you first start out, investing can seem overwhelming. As a result, technology has simplified the process of starting an investment portfolio, as well as automating your savings and investment activities.
1. At What age do you begin investing?
To open your own brokerage account, you must be at least eighteen years old. You can, however, register a custodial account with your parents, which will be transferred when you reach the age of 18 or 21.
If you are under the age of majority and wish to begin investing, you should register a custodial account with your parents, which you may log into and manage with them.
2. Can you invest in a Roth IRA if you’re under the age of 50?
Similarly, you must be 18 years old to start your own Roth IRA, although minors under the age of majority can open a custodial Roth IRA with their parents.
It’s important to remember that the IRS will not allow you to contribute more to an IRA than the amount of income you disclose on your tax return. For example, if you earn $3,000 in reported income for the year, the maximum amount you can contribute to your IRA is $3,000 per year. For taxpayers under the age of 50, the Internal Revenue Service authorizes a maximum contribution of $6,000 in tax year 2022.
3. What Resources Are Beneficial for Teen Investors?
In a nutshell, robo-advisors are automated financial advisors. Yes, the more knowledge you have about investment and personal finance, the more likely it is that you will accumulate wealth. However, you do not need to comprehend price-to-earnings ratios or pick individual stocks in order to begin investing – all you need to do is begin investing in a number of diversified index funds.
This is where the services of robo-advisors come in helpful. They will recommend the most appropriate investments for you depending on your age and risk tolerance, and you can then set up periodic recurring transfers to your account to supplement your income. They’ll take care of the rest. You may always adjust your investment strategy later on, if and when you decide to learn more about investing and become more hands-on with your portfolio, which you should do.
As free robo-advisors that anyone can utilize, my favorites are SoFi Invest, Ally Invest, and Charles Schwab. SoFi Invest allows you to get started with as little as $5 with your initial investment.
Micro-investing apps may also be a good option to investigate to help you automate your savings. If you want to combine micro-investing with a robo-advisor service, check out Acorns.
Is it necessary for teen investors to pay taxes on their investments?
Taxes on investment returns are technically due by everyone, at least for those who hold investments in taxable accounts. Moreover, in reality, you might likely not owe much, if any, in taxes on your returns while you are a teenager.
Because most teenagers earn so little, they often qualify for the standard deduction and other tax breaks available to low-income individuals. In real life, the majority of Americans do not pay any federal income taxes on their earnings. For example, in the fiscal year 2020, 61 percent of Americans paid no federal income taxes, according to the IRS.
In an event that you do end up having to pay a little amount of money in taxes, you will most likely fall into a low-income tax rate.
Even better, the earnings on investments are taxed as capital gains rather than ordinary income, reducing your tax liability. Because single people earning less than $41,675 in 2022 will not be subject to long-term capital gains taxes, it is possible that you will avoid paying taxes on investments you hold for a year or more entirely.
Why Should Teens Begin Investing Right Away?
The longer it takes for your assets to compound, the less money you will have to contribute from your own pocket in the long run. Your investment returns begin to accumulate, and you begin to earn interest on your interest.
For example, if you begin investing $75 a month at the age of 15, you will have moreover $1 million by the time you reach 65, assuming a historically average stock market return of 10%. Moreover, if you wait until you are 45 years old to begin investing, you will need to invest almost $550 per month to acquire the same level of wealth by the age of 65.
The earlier you start investing, the more faster you can accumulate wealth. This, in turn, assists you in beginning to develop passive income streams, which allow you to generate money while you sleep.
With a sufficient amount of passive income, you can achieve financial independence and stop working, no matter what age you are. I know people who retired at the age of 30 because they began investing when they were young. They are now free to travel the world, work on passion projects, volunteer, and run online enterprises on their own timetable, as they like.
Check out the average net worth by age to get a sense of how far you can get ahead of the herd and how much money you can make. You can then put your competitors in the rearview mirror by simply starting to invest before they ever have the opportunity to consider it.