Investment Allocation by Age: Birth to 10 Years Old

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At first glance, this headline may seem ridiculous. Little Johnny's going to start building his portfolio before he's out of diapers? Little Susie will shun Barbie dolls in favor of shares of Mattel stock? (See also How to Financially Educate Your Children)

In the first decade of life, investing is mostly something done on behalf of a child. But toward the end of that first decade, it is realistic for a child to begin to understand certain key investing concepts and to even begin investing on their own.

Developmental Stages and Money Understanding

There's some good research about what financial concepts kids can understand at various ages. According to the National Endowment for Financial Education's (NEFE) brochure, Simple Steps to Raising a Money-Smart Child (PDF), from ages 2 to 4, kids can start to see that money is a medium of exchange. We exchange money for food, toys, or other products and services.

From ages 5 to 7, kids can understand what it means to make trade-offs. I can get one name brand T-shirt for $10 or two store brand T-shirts for $10. And they can begin to distinguish between needs and wants

From ages 8 to 10, kids can learn some budget basics. Of my $5 allowance, I'm going to give 50 cents to charity, save $2, and have $2.50 left to spend. They can also learn about the benefits of putting off an immediate reward in favor of a better future reward.

The NEFE doesn't mention investing concepts until kids are older than 10. For example, between ages 11 and 13, it says they can begin to understand how compound interest and diversification work. Between ages 14 and 18, they can grasp the differences between stocks and bonds.

While kids don't all learn at the same pace, it's been my experience (we have three kids, ages 4, 7, and 9) that kids as young as 7 can start to understand what it means to own a piece of a company through stock investing. Even math concepts that are beyond what they're learning in school, such as compound interest, can be understood at about age 8 or 9.

Of course, you don't have to wait that long to start putting such concepts to work on their behalf.

Investing for Our Kids

The ideal time to start investing for our kids is when they're newborns. Everyone knows about the high-and-rising cost of college. Saving for College provides a helpful (and scary!) College Cost Calculator. Using the defaults, you'll see just how important time is to the compound interest equation.

For example, you'll need to save a stunning $602 per month starting in your child's first month of life if you'd like to cover all of that child's future college costs. But someone with a 10-year-old that's just starting to save will need to find a whopping $970 per month.

As your kids grow in their first decade of life, the more you talk with them about money, the sooner you may be able to get them started with investing.

Start Kids With Stocks

I generally don't advise people to buy individual stocks. I prefer mutual funds because of their inherent diversification. However, for young kids, a mutual fund is a very abstract concept. It's easier for a kid to understand that they own a part — a very, very tiny part — of Mattel, for example, than it is to understand that their share of an S&P 500 index fund represents a very, very tiny part of 500 leading U.S. companies.

It's also easier to understand one company's business. Even really young kids know what McDonald's is all about. You can talk with them about what specific food items they like and why, what commercials they like, the company's competitors, and more.

Here are three ways you could help your young kids graduate from consumers to owners.

1. A Brokerage Account

You need to be 18 years old in order to have a brokerage account in your own name. However, you could open a custodial account on behalf of your child. At age 18 or 21, depending on your state's laws, he or she will gain control of the money, including any money you have contributed on the child's behalf.

Here are a couple of the lowest-cost options:

• Capital One offers a ShareBuilder custodial account with no fees or minimum investment amount. Commissions are $6.95 per online trade. Through the end of 2013, Capital One is offering a nice incentive for opening such accounts. Just open an account and make one trade. The company will add $50 to the account within seven days.
   
• TD Ameritrade offers custodial accounts, also with no fees or minimum investment amount. Commissions are $9.99 per online trade.

The main downside to using a brokerage account to introduce kids to stocks is that you probably can't receive the stock certificate.

Most adult investors don't care about that, but for young kids, the more tangible the learning experience, the better. Getting something they can see and touch for their money — in this case, a stock certificate — can be really helpful. The two following companies are set up specifically for that purpose.

2. One Share or GiveAShare

As the company's name implies, One Share specializes in selling stock one share at a time — along with, for a price, a stock certificate. After opening a custodial account, you'll pay the actual share price for any of over 200 companies, plus $39.95 to receive a stock certificate. It can get pricier from there if you opt for framing, but you could frame it yourself or store the certificate in another way.

GiveAShare operates pretty much the same way, although it offers stock from about half as many companies as One Share.

If you or your child ever wants to redeem the share, you can do so through a stockbroker or possibly through the issuing company. But the point of buying a share of stock through One Share or GiveAShare isn't to be buying and selling on a regular basis. It's simply to get kids started with investing in a very tangible way.

3. Direct Stock Purchase Plan

One other option is to buy individual stocks through Computer Share, an organization utilized by companies ranging from Domino's Pizza to Nike to sell stock directly to investors. The website is not as user friendly as One Share and fees, minimums, and other fine print vary from company to company.

Will That Be Cash or a Certificate?

The Capital One ShareBuilder incentive offered a perfect opportunity for a little experiment. I asked my 9- and 7-year-old boys which of two options they would prefer.

With option A (a ShareBuilder account), they could buy one share of Facebook stock for about $25, and they would receive an extra $50 with which they could buy two more.

Or, with option B, they could buy one share of Facebook stock for about $25 and receive a certificate they could mount on the wall of their bedroom (I wanted to keep their out-of-pocket costs the same with both options, so I planned to pay the extra cost for the certificate). Which one do you think they went for? The cash or the certificate?

While I had guessed that they would want the certificate, I was still a bit surprised — and even disappointed — that they didn't go for the extra cash. But it reminded me that, at this age, stock market investing isn't so much about beating the market as it is getting into the market.

By the way, while I was working on this article, I received an excellent suggestion for a third option: Steer the kids toward the cash incentive and make them a DIY certificate!

What's been your experience with teaching your kids about investing at a young age? And what do you think your kids would go for — the cash or the certificate?

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