If you’re a parent, how can you set your child on the road to investing success?
One popular way is to buy young kids shares in companies familiar to them—maybe Disney, Apple, or McDonald’s. The idea is to get them excited about owning businesses that make their favourite products and services, with the hope that will turn them on to investing. I’m sympathetic to this idea, and it may work for some families—I’m certainly not trying to be a judgmental parent here. But I do wonder whether the best way to teach young people about investing is to turn them into stock pickers. I’ll offer three arguments against it:
It’s the wrong priority. On the list of key ingredients in an investment plan, picking the right stocks (or funds) isn’t even in the top five. At the top of the list is a commitment to regular saving. After that comes choosing the appropriate risk level for your goal, diversification, low cost, and minimizing taxes. Focusing on the stocks themselves is emphasizing the wrong part of the process. It’s like teaching your child to play hockey by buying him a cool stick rather than showing him how to pass, shoot and backcheck.
Many people take for granted that successful investing is all about choosing the best investments. But as Carl Richards point out, “searching for this best investment leads to behavior that ends up costing us money.” If we want to teach our kids about investing, isn’t it better to help them understand this as early as possible?
It encourages “home team bias.” Your familiarity with a company has no bearing on whether it’s a good investment. If you’re going to teach your child to be a stock picker, at least help her understand that point. Explain that loving the Toy Story movies, or her iPad, or Chicken McNuggets is not a reason to invest in shares of those companies, because the market doesn’t care about her personal preferences. Buying your favourite companies is the investing equivalent of cheering for the home team.
I’m glad my parents didn’t buy me stocks in the companies I knew and liked as a kid. I was proud of the Kodak camera I bought with money from my paper route, my favorite car was GM’s Corvette, and when my mom shopped at Eaton’s she used to buy me ice cream at the nearby K-Mart. It’s only with the benefit of hindsight that you can second-guess investing in these once blue-chip companies that later went bankrupt. If you love your BlackBerry, you should have no problem making this point to your child.
It can be impractical. A portfolio with a small number of stocks is not only poorly diversified, but unlikely to be cost-effective for a young investor. Discount brokerage accounts with small balances often carry account fees and high trading commissions, and even if you’re paying $5 or $10 per trade, that can quickly add up. (Remember, regular contributions are something you want to encourage.) Using DRIPs in a discount brokerage account is also impractical if you own a small number of shares, and direct stock-purchase plans strike me as a lot of paperwork for a new investor to manage.
A different way to invest with kids
I’ve heard people recommend that young investors build their portfolio one stock at a time, but I think this gets it exactly backwards. People with small sums are ideally suited to index mutual funds, which have no trading fees, instant diversification, seamlessly reinvest all dividends, and are perfectly suited to automatic contributions. When you’re just starting out, fund MERs can be very small in dollar terms: even 1% on a $5,000 account is just $50 a year, a small price to pay for establishing good habits. If your child eventually wants to pick individual stocks, that should come much later, once these benefits become less important.
So what do I recommend? The ING Direct Streetwise Funds are probably the easiest solution, since there are no account fees, no transaction costs, no minimums, automatic contributions are simple, and your child can manage the account online without having to open a brokerage account. If you have a relationship with TD Bank, an e-Series account is easy to maintain, even if it can be an ordeal to set up.
Other options may be a better fit with your family, and perhaps that will include some individual companies. I’d just encourage parents to make sure their child isn’t left with the impression that successful investing is about picking stocks.
I agree 100% with you Dan. When my daughter was 14 I got her started by putting 25% of her babysitting $ into a mutual fund we got her. It turned out to be a great way to teach her the value of investing by paying herself first. Now she is 30 and continues to pay herself first.
Totally agree Dan. TD can setup in-trust account so that your child gets the growth and you pay the tax on the gain. A small price to pay for what your child learns. This is perfect.
I think you are being unfair to TD.
Agreed, they initially had teething problems in setting up e-series for clients. But I don’t think the the procedure can be called anything close to an ordeal.
BTW, I am not affiliated to TD. In fact, I work for its competitor.
What are exactly the tax implications of opening a TD or ING direct accound under your child’s name? If you have to pay taxes as if it was your own account, maybe a 100% equitites fund would be better than a balanced fund in taxable accounts?
I have no problem with my child starting out on the “wrong foot”. I thank my lucky stars that I made my early investing mistakes when I was young and poor. We can all agree that a lot of mistakes were made by us as investor’s before adopting the “couch potato” style. If we had nothing but success none of us would be “couch potatoes”! I also believe the best way to learn is to try and succeed as well as try and fail. What a great lesson to teach your child that the 10 shares of RIM they bought at $50 are now worth $7. An inexpensive lesson in the grand scheme. I do not believe we can expect a smooth road in the investing world for our children without some hard lessons (the earlier the better). Carl Richard’s book points out that we try and stock pick because we, as a species, have a need to predict. Our kids are humans and have the same urges to be right. I say “Core and Explore!”
In reference to ACMZ’s comment, I wonder why one would just not have the account in the child’s name right off the bat. Is there a minimum age? Also, what is the minimum age one can file a tax return in order to take advantage of the personal tax exemption on any gains in the fund?
Because your child is under the age of majority, he/she cannot open an account in their name, therefore the next best thing is an in-trust account. I also asked that all documentation be sent in their name but that was not possible. It would have been nice for them to receive mail and such in their name. As for the tax implication, a balance protfolio would maximize the bonds at 18%, or 19% in some provinces (age of majority) and in my case, the accumulated amount in the account is not a big factor. As for the age one can file, the sooner the better. The earlier they start, the more room they accumulate for rrsp. They also get to know what pays for public services in Canada.
It’s not the filing of a tax return that builds RSSP contribution room but the accumulation of earned income. Capital gains or income from a investment portfolio does not build contribution room. If a child earns any income, such a from babysitting, newspaper routes, picking worms, helping neighbours, grass-cutting they should file a tax return in order to start building RRSP contribution room. Unless they are making over about $11,000 in Ontario they won’t pay any income tax but they will earn RRSP contribution room at the rate of 18% of earned income and contribute to that RRSP when they have the funds at any time in the future.
I am wondering, though, would it not be possible to buy common stocks, say a Canadian bank stock paying a dividend, ask for the physical stock certificate (which one has a right to), then endorse the stock certificate to the child so that it is then owned in their name? This would allow them to report the dividend income on their tax return and claim the dividend tax credit, which would mean that in Ontario, with no other income they could earn almost $50,000 in dividend income tax free? Also, if they ever sold the stock they would enjoy the lower tax rate their lower tax bracket affords them. Just a thought.
Hi Dan, great post. I think this applies to everyone who is starting out with a small sum of money. The priority should never be picking the right stocks and funds at the start.
I was curious about the question I posted regarding gifting a stock certificate to a child and did some research. Apparently there are attribution rules if you transfer assets such as mutual funds, stocks, bonds to a child under the age of majority and even if you make an interest-free loan to a child for investment purposes.
But the attribution rules don’t apply to capital gains so when you transfer an investment to a child or invest on his or her behalf, any money made by selling that investment for an increased price is taxable in the hands of the child. And the attribution rules only apply to first-generation returns on the money. So, any returns made from re-investing the returns from the investment are not attributed back to the parent.
So, I am wondering if it would be possible for a parent to buy an index fund or ETF and then legally transfer it to the child? I know that brokerages don’t allow children under the age of majority to have accounts, but this would circumvent that. In this way the child could sell it as it gained in value as the child aged (and then re-purchase it) and not pay tax. The only cost would be the transaction cost for selling and re-purchasing the investment. This would allow the gain for the entire investment (as long as the gain per year did not exceed the personal exemption) to be tax free until the child started to earn other income.
Also, if you lend money to your child and charge market interest then the attribution rules do not apply. But, if the market rate of interest required to be applied to the investment is greater than the dividend on the investment then it’s a cash drain for the child.
This is a good post Dan, and it reminds me of a shortcoming in many of our schools: stock picking contests as a way to financially educate kids. This may be the first year my school hasn’t “played” one of these games. Those contests are awful. Teachers might as well take kids to the local casino.
I remember as an adolescent receiving stock in CP and BCE and other companies. Typically though, these were chosen not only for their perceived bedrock status, but also for the fact the company occassionaly offered the chance to buy single stocks without paying a fee. The small investor could send a cheque for the value of a few stocks and slowly build a portfolio.
However, now that I am older and wiser and taking care of my own money, it’s apparent even the benefit of buying shares directly from the company is only good if you are happy with the limited number of corporations who would let you do it efficiently. Thus an even more restricted and risky form of stock picking.
Thanks to everyone for your comments. I was expecting a little more disagreement. :)
@Ram: TD’s reputation regarding the e-Series funds is terrible. Browse the comments under this post:
@Noel and others: As you’ve discovered there are attribution rules regarding investments in the name of a minor child, so please consult with an accountant or tax adviser before you set up an account.
@Andrew: Yes, I agree stock picking contests are the most counterproductive form of financial education imaginable. Unless of course they are used to teach the randomness of short-term stock price changes and the futility of the activity. :)
Hi Dan – totally agree with the article and several of the posts that follow.
My children’s incomes have gone into a broad market ETF’s and tax returns have been filed to accumulate RRSP room. As the kids have been turning 18 money gets transferred over to fund TFSAs with the same ETFs as well as setting up an RRSP. The RRSP contributions are made but the deduction is saved for future years when (hopefully) they will be high(er) income earners.
Agree that stock picking contests in school definitely teach several wrong lessons! Sadly, what Al M says also has the ring of truth, no matter how much reading and learning one does – there is no substitute for having your favourite stock go down in flames and realizing that it isn’t likely coming back.
I agree with your analysis and have setup an ING Streetwise account with my daughter to put some of her retail earnings into.
However, when I tried to invest $60 I was told that there is a $100 minimum. I thought (and you state) “no minimums”?
Any ideas on why? I put the purchase through, and it was rejected, so this is not a voice message or anything …
I just doubled the next month, but it is annoying.
@Bill: Sorry, I believe there may be an initial $100 minimum deposit. And if you set up an automatic contribution, I believe it must be at least $25 a month. But these are among the smallest minimums out there. Some brokerages charge annual fees on balances less than $25,000, for example.
I think a good idea to teach kids when old enough is the power of compounding. I still remember my math teacher showing us an example in class and it stuck with me.
@Joe K: I agree, and that raises another relevant point. I often here people extol the virtues of dividend stocks and DRIPs because of their power to compound, but all investments compound if you don’t spend the distributions. The power of compounding comes through time, not through payout policy.
The only advantage of a single stock or small stock portfolio for education purposes is that it can better facilitate the idea of what a corporation is about – the nature of that particular business, the nature of business in general and its place in the economy. This can be accomplished through ownership of stock baskets as well but the message is more general and abstract unless an individual stock within the basket is centred out for analysis. An ETF may be a bit more abstract because the basket is so large. My experience is that younger kids like the concrete. It is easy to track the value of a single stock and the reasons for changes in that value as they relate to the economy as a whole and the planning and decision making of the individual business.
I would not buy an individual stock for my child for investment purposes and would stick to index ETFs but might buy a single share or two for education purposes.
I’ve been looking into setting up an account for my 16 year old daughter these last few weeks. What I’ve found is that if an account is set up in trust and the investment grows solely through capital gains the tax issues concerning primary and secondary growth (payments on my part) can be avoided. I’m going to investigate to see if its worthwhile to setup an account where I could purchase efts then perhaps (hxt)? The purchase commissions and minimum account balance fees would need to be very low as there is not a lot of money being invested. I’m currently with TD Waterhouse but am open to any firm that would be most cost effective. Does anyone have any suggestions as to which brokerages might be best? Other wise I’m leaning toward ING streetwise funds.
@Andrew: That sounds like a fair compromise. I think it’s possible to teach kids some lessons with individual stocks while at the same time making it clear that successful long-term investing is not about learning to analyze companies and forecast the economy. I would agree that index funds are too abstract for young kids to understand, although by high school they will certainly be able to get it.
@Phil: Several brokerages offer HXT and HXS with no commissions, but you will have to check what their annual account fees are. I believe they all charge fees on balances under $15,000 or so. Questrade has no account fees and $5 ETF trades, which may be a possibility. Whether or not any of these brokerages offer in-trust accounts for children I don’t know. Can any readers help here?
Well I went a different way. I opened an account for each of my gkids in my Tfsa and made them the beneficiary . I set them to drip and I use my Royal bank cash back visa for cash to add to it. I also have some trusts in TD and use the e accounts. There in my wife,s name as she has no income so the interest earned does not hurt. However my wife has now inherited a bit of money. Think I will give it to my kids so they can start education accounts for the Gkids.
I wish you guys would update or create a new post for this topic.
What are the best options in 2017.
What type of accounts should I create for my Kids, an informal in-trust account with Drip?
Would you buy ETFs or Mutual funds? Should we buy the Horizons Funds that automatically re-invests dividends and creates capital gains instead for tax efficiency?
Very hard to find information on this topic for canada…
Of course the idea of investing into an index fund is a sound advice no matter whether you are an adult or a child. After all Eugene Fama Nobel Prize winner of the Uni of Chicago advises this.
That said, stock picking is sill a very useful skill, period. The same Eugene Fama says that some people have the skills to beat the index consistently…. Buffet Simons Cohen or any successful CME floor trader are examples.