Financial Literacy & Independence for Teens - Step 4 - Investing
KEY POINTS
Teenagers are at an ideal stage to begin investing and setting their short-term and long-term financial goals.
Successful investing involves the coordination of interdependent disciplines including risk management, budgeting, cash flows, taxation, accounting, and more.
Fees are not always properly disclosed, and they can have a detrimental impact on portfolio returns.
Our proprietary due diligence checklist will help your teenager find the best qualified advisor.
Empowering Our Teenagers
Financial literacy is an essential life skill that should be taught as early as possible as it can profoundly impact an individual’s future. The ability to navigate the world of investing is an invaluable gift that will pay a lifetime of dividends.
Parents and teachers must seize the opportunity to teach teenagers how to invest as it instills discipline, critical thinking, and responsibility while simultaneously opening the door to a world of financial opportunities, independence, and long-term success.
The following steps will provide a culture of financial literacy while providing confidence and foresight to make wise financial decisions that will shape their financial future.
Education
Teenagers must understand that successful investing requires a commitment to a lifetime of continuous education. It is a complex process that involves several interdependent disciplines including, but not limited to:
Investing
Risk Management
Cash Flows
Accounting
Legal
The investing landscape is in a state of continuous evolution that can be challenging to keep up with. The past 60 years or so have been profoundly impacted by the following selected events,
Index funds
Exchange traded funds
Globalization
Private equity and venture capital
ESG investing
Quantitative investing
Regulatory changes
Robo-advisors
Cryptocurrencies
No one knows what lies ahead. The best way to prepare for the unknown is to continuously equip yourself with knowledge while surrounding yourself with a qualified and trusted team of financial advisors.
Start Early
The power of compounding can significantly increase wealth over time.
What is compounding?
It is a foundational investing concept that allows an investor to earn interest or returns on both the initial principal and accumulated interest or returns from previous periods. The concept applies to various financial instruments including savings, investments, and loans.
The earlier you start, the more impactful the compounding effect. The reinvestment of such passive income (e.g., dividends, interest) can produce an exponential impact on long-term wealth accumulation while providing protection against inflation.
For example, a $1,000,000 retirement fund could be created by allocating approximately $502 per month to savings for 40 years while earning a 6% annual rate of return. If you cut the savings period in half to 20 years, the monthly savings requirement more than quadruples to $2,164.
Goal Setting
Successful financial planning and wealth management is dependent upon establishing short-term and long-term investment goals.
Investment goals provide clarity and focus as investment strategies can be aligned with investment objectives. Common milestone objectives may include saving for an education, wedding, house, or retirement.
Each goal may have a different time horizon. For instance, the purchase of a house and funding retirement may have time horizons of 5 and 40 years respectively. Longer term time horizons can typically allow for more aggressive investment strategies.
Well defined investment goals can provide great motivation and lead to a greater degree of discipline. Clearly defined goals can provide critical guidance and help resist making emotional investment decisions during periods of elevated market turbulence.
Goals should be developed in a structured manner. We recommend implementing the SMART-ER principle when goal setting. This process ensures each goal is,
Specific
Measurable
Achievable
Relevant
Time
Evaluated
Reviewed
Risk and Return
Investments come with varying degrees of risk. Typically, investments with higher risk levels offer higher potential rates of return, but they also carry higher potential rates of loss.
There are many types of investment risk to consider before selecting an investment to include in a portfolio that supports a specific short-term or long-term goal. A single investment may be exposed to the more than one of the following risks,
Interest rates
Currency
Inflation
Geopolitical
Credit / Default
Counterparty
Liquidity
Opportunity
Information
Education
Concentration
Business and Financial
Diversification
Diversification is a fundamental risk management strategy utilized to optimize investment returns. It involves allocating investments across different asset classes, industries, geographic regions, and individual securities.
There is an old adage,
Do not put all your eggs in one basket
〰️
Do not put all your eggs in one basket 〰️
A well-diversified portfolio is constructed in the hopes of withstanding the impact of market fluctuations and economic uncertainties better than a concentrated non-diversified portfolio. When one asset or sector underperforms, the overall portfolio can still benefit from the performance of the other assets.
Diversification does not eliminate risk or guarantee positive returns. There is always the possibility of loss. Over-diversification can potentially lead to subpar performance.
The creation of a diversified portfolio is not a one-time event. The portfolio must be monitored as market conditions are continuously changing. Periodic rebalancing may be required.
Avoid Emotional Investing
We have all watched a stock’s price soar and experienced the fear of missing out. Others have been pitched various get-quick-rich schemes offering extraordinarily high returns with little risk.
Some investors will jump in and invest without performing adequate research. Fear and greed are the basis for most impulse driven decisions.
Emotional investing can lead to poor investment decisions, and such can have a detrimental impact on achieving short-term and long-term goals. As partially described above, the following steps can eliminate the risk of emotional investing,
Education
Research
Goal setting
Set realistic expectations
Diversification
Avoid market timing
Create an investment checklist
Filter sensational news headlines
Obtain professional advice
Fees
Investment fees are charged when investing in financial products or instruments. These fees can be substantial and will impact overall portfolio returns.
Fees should be clearly disclosed by every financial institution; however, such is not always the case. Investors are advised to perform their due diligence to ensure they are aware of the existence of such fees, how they are calculated, what rate is utilized, and when they are charged.
There are many types of fees, including by not limited to,
Brokerage fees
Publicly traded securities (e.g., stocks, bonds, options) are typically bought and sold through a brokerage account. The brokerage firm will charge a fee for each trade executed. Such may be a fixed fee amount, or it may be based on a percentage of the trade amount.
Many trades can be executed on-line without any assistance. The fee may increase if you require the personal assistance of a broker to facilitate placing the trade.
Expense ratio
Mutual funds and exchange traded funds incur fees related to managing the fund. These fees may include the management fee, performance / incentive fees, custodian fees, audit, accounting, legal, and regulatory fees related to filing the annual fund offering documents and ongoing disclosures.
The fees are normally disclosed as part of the management expense ratio. For example, $250,000 annual fees on an average asset under management balance of $20,000,000 would result in a ratio of 1.25%.
The investor benefits from a lower ratio. Such ratios can be compared across funds of a similar investment strategy to ensure the investor is paying a reasonable fee for the services provided.
Front-end and Back-end Load fees
Some mutual funds may charge a commission (front-end load fee) when purchasing the fund, or a commission (back-end load fee) when selling the fund. Both types of fees can be substantial and have a significant compounding impact on a portfolio’s long-term performance.
Advisory fees
Professional investment advisors may provide valuable guidance especially for teenagers that are new to the world of investing.
The three primary fee models employed by advisors are commissions (e.g., fee based on percentage of each trade), fee-based (e.g., fee based on a percentage of assets), and the fee only model (i.e., no commissions as the advisor only earns fees based on the services provided).
Robo-advisors offer investors an alternative to engaging with a live advisor. The robo-advisor model has grown to offer a wide variety of services and access to a diverse investment universe. For an additional fee, this model may offer access to live advisors, as required by the investor.
Account fees
Some investment accounts, retirement accounts, or managed platforms may charge maintenance or administrative fees. Such fees should be disclosed to the investor in writing and clearly referenced in the monthly or annual statement provided to the investor.
Inactivity fees
Some brokerage firms may charge an inactivity fee if the account does not trade or remains inactive for a specified period.
Foreign Currency Exchange Fees
Your bank or brokerage firm may charge you fees exceeding 4% when converting funds to invest in securities denominated in a foreign currency. Companies like Wise can substantially reduce or eliminate these costs.
Tax Advantaged Accounts
There are several types of investment accounts available to investors and each one offers unique characteristics that may have a substantial impact on an investor’s long-term wealth. We will briefly highlight accounts that are taxable, non-taxable, and tax deferred.
Taxable Accounts
All income earned (e.g., capital gains, dividends, interest) in such accounts is taxable in the year it becomes realized regardless of when the funds are withdrawn from the account.
Non-Taxable Accounts
All income earned in such accounts grows tax free and can be withdrawn tax free.
Tax Deferred Accounts
Contributions to these accounts typically generate a tax deduction for the contributor. All income earned in such accounts grows tax free. Withdrawals from these accounts become taxable to the investor in the year of withdrawal.
Employer Contribution Matching
Some employers offer to match employees’ contributions to a company pension plan. For example, an employer may contribute $2 for every $1 contributed by the employee. The employer’s portion is often subject to a vesting period.
Such savings plans often provide the added bonus of access to a professional financial advisor and a robust investment platform.
Monitor Your Investments
Investment performance should be monitored regularly at the portfolio level, asset class level, and security level. Markets change constantly and may necessitate a change in investment strategy.
BOTTOM LINE
Teenagers should be encouraged to develop and maintain a robust and continuous education related to investments. There are numerous tools available to construct, monitor, and maintain an investment portfolio capable of reaching the desired short-term and long-term financial goals.
