This summer my son made quite a bit of money as a lifeguard at a sleepaway camp and by giving private swim lessons after camp was over. I’m trying to encourage him to make sound money decisions at an early age. Any suggestions for what he should do with these funds?
This is a great question! It is practical for many youngsters as summer winds down. It’s a big accomplishment to work hard and make money, but managing that money responsibly is just as important. Below is a framework to use when considering how to manage your son’s earnings. Hopefully it will serve as a springboard for your son to become more educated on personal finances and investing.
Open a bank account: This point may seem obvious to many readers, but for some it’s easily overlooked. There tends to be a false sense of security from having cash at your fingertips. In reality, it’s dangerous to keep too much cash on hand. It can be lost, stolen, or damaged. Keeping your money in a bank offers security and protection through FDIC insurance and SIPC. It also offers you opportunities to put your cash to work so it can grow over time.
If your child is not old enough to open their own account, you can open a custodian account on their behalf. The process of opening your first checking or investing account should be an educational experience. It’s worth sitting down and doing that together.
Determine your time horizon: Is this cash going to be used to pay for fun things throughout the year, like going out to eat with friends or seeing a movie? Alternatively, is this money earmarked for use at some point down the road? It may be the seed for a down payment for a home, to start a business, or just to start life after the child graduates from school. One’s time horizon is foundational in determining how to allocate the money. It’s impossible to make prudent investing decisions without a clear understanding of when you will need the money.
A discussion about the time horizon may open a conversation about the importance of delayed gratification and saving for the future, which is the essence of all personal finance decisions. Understanding these concepts early can have a tremendous impact on one’s future finances. If saving it all isn’t practical, encourage the child to split the funds. Some money can be used for more immediate fun and the other half should be saved for the future.
If short-term money: If this is spending money until next summer, then the funds should not be invested. Sure, you may not earn a return on your money. However, you also won’t experience fluctuation in your cash due to market volatility. A simple checking account should suffice. Take this opportunity to educate your child about how the banking system works. Obtain a debit card and a credit card and teach the importance of spending within your means and always paying your credit card off in full every month. This is also a great way to start building a solid credit history.
If the money is short-term, but not immediate spending money, then consider a money market fund or a short-term CD. Given the rise in interest rates, earning a return of approximately 5% (give or take a bit depending on the day) is a very attractive option for simply sitting in cash or cash equivalent investments. The ability to appreciate the concept of making money on your money without any ongoing effort is a good lesson on proper cash management.
If long-term money: If the income made over the summer is for the long-term, to use after college or for a down payment on a home in 10 years, then it should be invested in an area of the market that will appreciate over time and outpace inflation. For many, the best place to do this is in the stock market, which is accessible to the masses, easy to manage risk through diversification, and fully liquid.
Individuals can invest in the market on their own or it can be done by hiring a competent financial advisor. If your family already works with a trusted advisor, reaching out to them may make the most sense. Many advisors have high minimums; being part of a larger relationship would make the advisor more inclined to sit down with your son to discuss his options. I would caution you from going into a local branch of your bank for investment advice. Many times, those folks are compensated by pushing specific products and have sales quotas that must be achieved. Consequently, they don’t necessarily take the time to understand what the client is looking to accomplish. It is not a conducive model for getting comprehensive financial advice.
Anecdotally, when I first started my investment journey, I met with a gentleman at a bank who put me into B share mutual funds. These shares have fallen out of favor and are not permitted by some firms given their extremely high fee structure. I didn’t know the difference between mutual fund share classes at the time. I now make it my business to educate investors on how to properly choose a financial professional with whom to work.
If you prefer to pursue this task as a do-it-yourself investor, then an account can be opened at many low-cost brokerage firms like Schwab or Fidelity. There are literally thousands of stocks and even more mutual funds/ETFs to choose from. Simply choosing a target-date fund, or a fund that manages investor’s money based on the year they will need the funds, may be a prudent option. While this is a cookie cutter approach with many limitations, it’s also a good way to avoid blowing up your portfolio.
Day trading and buying individual stocks is ill advised. Treat investing as a serious endeavor and not as a recreational activity, like gambling. Remember, if your strategy is plain vanilla and boring, you are likely on the right track.
Bonus suggestion: Another idea for kids (or their parents) that are long-term planners, is to set up a Roth IRA account. A Roth IRA is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement. Roth IRA rules dictate that as long as you’ve owned your account for at least 5 years and you are at least 59½ years old, you can withdraw your money tax free. Having these funds grow tax-free for five decades or more can lead to accumulating a substantial nest egg.
Fun fact: When I was in high school, I spent a summer working as a lifeguard at the local JCC. My father suggested that I open a Roth IRA account. He offered to match my earnings for the summer with a contribution to my new Roth IRA. (Note: You don’t need to put your own funds into the account, but in most situations, you do need to have earned income in order to contribute to a retirement account. So, if I made $1,000, the contribution to the Roth IRA cannot exceed $1,000 by either me or a third party.) I was able to use my lifeguard earnings for hanging out with friends and my father generously deposited money for my retirement. (Thanks, Tati!). This allowed me to start saving for retirement in high school. It also instantly made me the coolest 16-year-old in my class! You mean every student isn’t excited by a Roth IRA?!
At this stage of your child’s life, the most important thing is to engage them in discussion about basic financial literacy. The earnings from this summer will help facilitate this conversation and will hopefully be the first step in his personal finance journey. If he takes you up on saving and investing for his future, that is just gravy.
