A client recently asked us if they should give their early-20s college graduate money to get started in investing. To a lot of people, this seems like a great idea.
As with most financial endeavors, there are pitfalls to avoid, and approaches that add more value. Here are five strategies to help your adult kids get started in investing, and not all of them require any financial contribution from you.
Strategy 1: Get a commitment
Giving your adult child money will teach them one thing: how to receive gifts of money. It won’t teach them how to make themselves financially self-sufficient.
Before you contribute any money of your own to the cause, make sure your child shows a willingness to make their own sacrifices for their future. Just like many employers match 401(k) contributions, your child should be required to contribute their own money before you give them money to invest. We suggest your contribution should do no more than match what your child contributes from their own earnings.
Strategy 2: Make it interesting, but always model good investing habits
Helping your graduate see the power of compounding and the advantage of starting young is often all it takes to get them to commit to a lifetime of saving and investing. There are numerous examples of how 10 years of investing starting at age 22 can beat decades of investing starting at age 32. They don’t have to commit to FIRE (financial independence, retire early), but the more time their investments have to grow, the fewer dollars they’ll have to contribute to their own financial independence.
Encourage them to consider the same type of broad-based, inexpensive mutual funds that you use to support your retirement. Successful investing isn’t exciting (like gambling is); it’s most often uneventful. But slow-and-steady works.
True, they may be more interested if they can buy stocks of companies that are relevant to their lives. (It’s no longer a problem if they can’t afford the large per-share price of individual stocks: Schwab is now offering fractional shares of stocks in the S&P 500, with the same low-to-nonexistent trading costs as other stock trades.1)
If they do prefer to put their contribution into individual stocks, they might join an organization like BetterInvesting, which will help them see that success with individual stocks takes research, work, and patience.
No more than half of their own contribution should go into individual stocks—the rest should be in low-cost mutual funds. Whatever they may choose to invest in, your own contribution (if any) should always be invested in the same kind of mutual funds that you use. Get their agreement that if they sell any funds from your contribution, they must re-invest it in other funds that you approve of.
Strategy 3: Be tax-efficient
If your recent graduate has a job that pays well, they’re likely responsible for income tax at the highest tax bracket of their life so far. This is a great opportunity to help them become more tax-conscious.
They might be best off to put their contribution into their employer’s 401(k) (or other workplace plans), especially if they will receive an employer match. Help them understand that the match is free money and that each year they don’t max it out is a lost opportunity, never to return.
Of course, you can’t put money into their 401(k). But you can give it to them to put into an IRA, or even make up for an increase in the amount they contribute to the 401(k).
Whether they use traditional or Roth contributions in their workplace plan depends mostly on how much income tax they stand to save. But your child’s young age likely makes the Roth the better bet.
If their employer doesn’t sponsor a workplace plan, you can guide your graduate through the process of opening a Roth IRA. They can contribute up to the annual limit or the amount of their earnings, whichever is lower. But this limitation describes only the amount of their contribution, not where it comes from. Even if your child can spare only a little of their earnings for their IRA, they’re allowed to make contributions from funds they receive from you (or anyone else).
Strategy 4: Offer a professional perspective
Most recent graduates don’t have the resources to be good candidates for an ongoing relationship with a traditional financial planner (although this is changing as the industry offers more ways to find unbiased financial advice without product sales). Your own financial planner may offer an inexpensive short engagement to help your child get off to a good start. With the right guidance, they’ll be in a position to benefit from ongoing planning years ahead of their peers.
Instead of giving your child cash to invest, they might be better served with a short planning engagement that helps them make the right decisions on insurance, cash flow, retirement savings, first steps in investing, and more. As always, it’s best for them to work with a professional without conflicts of interest; this makes fee-only planners preferable.
Strategy 5: Let them be themselves
Of course, you want your child to make the best decisions and commitments possible. But this is happening at a time when they’re taking some important new steps to independence. Make sure you’re not too heavy-handed. You’re already controlling a lot of the process—don’t try to make their investments into your version of perfection. And trying to vicariously overcome your past investing mistakes through your children is a recipe for a strained relationship.
Our children should be themselves. They can’t, and shouldn’t, see the world exactly as you do. As Ken once joked about his own daughter, “It’s almost like she’s a whole different person.” Be sure they have enough control over the process that they feel their own motivation to take on these new responsibilities.
1 Schwab Stock Slices™