By Susan Beacham
Editor's note: This is the sixth in a series of six columns on how parents can help their kids get smart about money.
First, let me tell you what this month's column is NOT about. It is not the "be all, end all" of investing tutorials for you or your child. It is not a list of stock tips or mutual funds to buy. Instead, it is an introduction for your child to the ideas of long-term goal-setting and investing.
When you save money in a bank account, it earns interest safely because it is protected by the federal government. But the rate of interest is fairly low, which means your money will grow s-l-o-w-l-y. When you invest money, it has the potential to grow faster. But investing involves risk, so there is a chance you could lose some or all of the money you invest.
So why invest? Because the higher the risk, the higher the potential return. And there are ways to minimize the risk - by investing long term (10 years or more). In other words, money plus time equals more money.
Question of the Month
My older kids love to play the stock market. They use pretend money and always seem to win. Is this a good way for them to learn about investing?
It is amazing how easy it is to "win" when you are investing in companies using pretend money. When you use your own real, cold, hard cash, money that you have earned, the decisions you make with that money get more serious. Winning gets harder when faced with the risk of loss.
I don't think it will harm your kids to play the market with pretend money, but it is important to make sure they buy at least one share of stock with their own real money to experience the difference. That way they will learn to manage risk - a very big part of the equation when you are investing for real.
To drive home this point, ask your child to think about something he might want or need 10 years from now. The easiest approach is to first ask your child to add 10 years to his age. Let's say your child is 7. In 10 years, he will be 17. Would a 17-year-old want a car or money for college? This exercise helps a child focus on the long term. Hopefully, once your child is 17, you will have taught him to think about what he might want at age 27, such as a down payment on a house.
Explaining "Investing" to Kids
Investing is buying something with the hope it will earn more money over time. One way is to put money into the stock market. There you can buy a "piece" of a company, or a stock. The price of a stock is based on the company's ability to generate a cash profit. There are other ways to invest, such as buying a bond, a mutual fund or real estate. But for now, let's start with stocks.
And we're going to start small, with a single share. Buying a single share of stock can be expensive if you go to a full-service broker. But there are discount brokerage options available, such as www.ShareBuilder.com, which sells a single share for a fee as low as $4, provided you invest regularly.
Even one share makes you an owner of the company and entitles you to get copies of the annual report, a sort of report card on a company that tells shareholders what a company does and how well it does it.
Explain to your child that sometimes the stock market is like a roller coaster with a lot of ups and downs. Changes in the economy or the company can affect profits and the stock's price. If the company makes money, you share in the profits. If the company loses money, you share in the losses.
So, if you sell your stock on a day that the company isn't doing well, you can lose money. However, if you paid $1 for your stock, and you sell when it is worth $5, you make five times what you invested. If you have the nerves to ride out the lows, you may make a lot of money.
Choosing a Company
To help your child choose a company to invest in:
- Pick a product your child likes. It may be a favorite toy or food or athletic equipment. When my daughter, Allison, was ready to buy her first share of stock, we zeroed in on her interest in puppies and chose to invest in PetSmart. Our ability to link her first stock purchase with something she loved and a place she could visit made investing come alive for her.
- Research the company. Help your child look up the company's annual report online or at your local library. How does the company earn money? Is it profitable? Why? Does this company plan to grow bigger and better? Search the Web for news reports and the company's Web site as well as that of any competitors. With whom does this company compete? Is the company better than its competition?
- Determine how you'll keep track of the company performance. Tracking the performance of the company and how the stock price responds to the ups and downs is an important part of learning how the stock market works.
The point of this initial foray into the stock market is to learn how to buy and sell a stock, not necessarily to make money. So don't worry about whether your child picks a dud. Just worry about whether he or she has learned the mechanics of the market - and the long-term vision needed to be a wise investor.