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Money tools for teens
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August 7, 2001: 10:47 a.m. ET
Getting an early start on saving and investing can benefit teens greatly
By Bettina Teodoro
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NEW YORK (CNNfn) - When David Leung was 10, his parents decided to start saving for his college education. But rather than put money away on their own, they agreed to let their son have a hand in his future.
As a reward for doing well in school, Leung's parents gave him money to invest in the stock market. He could pick whatever stock he wanted, so long as he had done the research and could prove the company was worth the investment.
After a few trips to the local library and a primer from his father on finance and investing, Leung picked Microsoft.
"My first computer had Windows, and I looked around and saw that everyone had Windows. So I thought maybe this would be a good start," he says.
It was. Eight years later, Leung's initial $7,000 investment has grown into a portfolio worth about $350,000 more than enough to pay for his four years at Massachusetts Institute of Technology.
The magic of compounding
Leung says what turned him on to investing was the lure of compound interest.
"Instead of having to work to make money, you have your money work for you," Leung says.
According to Patricia Jennerjohn, a certified financial planner (CFP) with Focused Finances in Oakland, Calif., an 18-year old who invests $2,000 each year will see his or her investment grow to about $268,000 by age 50, assuming an 8 percent average annual rate of return.
But, if the 18-year-old waits just six years to begin investing, he or she will earn about $160,000 by 50, a difference of $108,000.
"So there is a cost of waiting, and it's huge," says Jennerjohn. "That's an important thing to see."
But an annual investment of $2,000 may be too rich for a teen-ager who works for minimum wage three months of the year. This should not be a deterrent. At such a young age, Jennerjohn says, "The important thing is not how much you are saving it's that you build a habit."
What to do with your money
If you are wary of wading into the stock market, you can put your money in a savings account, money-market account or certificate of deposit. However, understand you will earn a low rate of return, about 3 to 5 percent a year.
If you want to see your money grow more quickly, financial planners recommend mutual funds. These offer "a lot of bang for the buck," and require minimal management for an investor, says Deena Katz, a CFP with Evensky Brown & Katz in Coral Gables, Fla.
Some planners say teens should stay away from investing in individual stocks. (By law, kids cannot invest on their own. They have to use a custodial account and need a parent or guardian's permission). This requires a lot of research, and may not be a good choice for students who will need to cash in their investment within a short period of time.
"For anything less than five years, you shouldn't be buying common stocks," Jennerjohn says. "You want a return of your capital as well as a return on your capital."
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David Leung's StocksQuest site can help teens learn about the stock market. | |
However, other planners realize that choosing and analyzing stocks can provide teens with a valuable learning experience.
"Let them have a sense of managing their own money, as opposed to having someone else like a mutual fund manage it for them," says Samuel Hull, a CFP with Northstar Financial Planning in Bedford, N.H. "It teaches them much more about analysis of companies."
As for Leung, he says he opted for stocks instead of funds because he felt he could manage his money better on his own rather than pay someone to do it for him.
And he does his homework. Leung says he looks to see that a company is growing at 15 percent or more and has a dominant position in its market sector. In addition, he buys only when he deems the stock price "reasonable," an evaluation he usually makes by looking at the company's price-earnings ratio.
However, "with tech stocks it's a little harder," he says, "so I generally avoid the companies that have no earnings and are quite risky." In addition to Microsoft (MSFT: up $0.78 to $66.91, Research, Estimates), which comprises 60 percent of Leung's holdings, his portfolio includes Intel (INTC: up $0.18 to $30.46, Research, Estimates), Cendant Corp. (CD: up $0.31 to $19.90, Research, Estimates), Coca-Cola Co. (KO: up $0.09 to $44.70, Research, Estimates), Lucent Technologies (LU: up $0.08 to $6.63, Research, Estimates) and Mattel (MAT: up $0.26 to $17.67, Research, Estimates).
Leung, one of the authors of a Web site called StocksQuest that provides young investors with information about the stock market, considers himself a moderately-risky investor.
"I don't go for the super high-flyers that will net you 100 times your money," he says, "but I'm not going to lose all my money either, because I just pick dominant tech stocks mainly."
Leung also is a long-term investor, and says he rarely sells so long as he is comfortable that his investments are in solid companies. All in all, he says he has "probably traded five times total."
Eyes to the future
To Leung's credit, he picked Microsoft and not some dot.com stock that since has imploded, which has resulted in him quickly earning enough money to pay for college and more.
But for other families looking towards college and not willing or able to go the same route, planners recommend some safer options.
Hull suggests opening an education IRA, because the current $500 per child annual contribution limit will increase to $2,000 next year. Anyone parents, grandparents, even the child can contribute after-tax dollars, and the withdrawals will be tax-free as long as they are applied towards qualified education expenses.
Jennerjohn favors a state-sponsored 529 savings plan, which allows a family's investment to grow tax-deferred until the money is withdrawn to pay for education expenses. The maximum amount depends on the state, with some states allowing more than $100,000. The funds then are taxed at the child's rate. Starting in 2002, the withdrawals will be exempt from federal tax.
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Some early planning can help teens pay for college. | |
While planning for college is a no-brainer for most teens, some planners wonder if the average teen-ager will look 10 or 20 years down the road towards the purchase of a home, or even further ahead to retirement.
Stephen Hample, a CFP with Financial Planning Associates in Bozeman, Mont., says he knows of 40-year-olds who have never considered retirement. Therefore, he says, a forward-looking teen can make crossing that milestone much easier.
Hample and others say the best option for a teen with earned income is to open a Roth IRA, which allows investments of up to $2,000 after-tax per year. The teen does not see any immediate tax advantage, but will be allowed to make tax-free withdrawals after the age of 59-1/2.
Roth IRAs also allow early tax-free withdrawals (although there is a 10 percent withdrawal penalty) in certain circumstances, including up to $10,000 for the first-time purchase of a home.
However, Jennerjohn says teens should not open a Roth IRA simply for that reason, because they have enough time to plan better. "I always think of taking money out of a retirement plan as a back-against-the-wall resort," she says.
Instead, she recommends saving for a 20 percent down payment, say $40,000 on a home with a price tag of $200,000. Thus, an 18-year-old who wishes to purchase a home within 10 years would need to save about $2,800 annually, assuming an 8 percent annual rate of return.
"With that long term of a goal, they could invest more aggressively in stocks or equity funds," she says. 
* Disclaimer
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