While leading a couple of short workshops about money with a group of middle school students recently, I told them they have an asset that’s incredibly valuable. Understandably, they looked somewhat surprised. After all, most of them don’t have much money, and their income, if any, consists of an allowance or money they earn babysitting or mowing lawns.
However, it didn’t take long for them to catch on. They have time—God willing, quite a bit of time. And time is one of the most important ingredients for successful investing. I explained the formula this way: Money + A Decent Rate of Return + Time = approximately… A Lot!
After working through some teaching on the importance of giving away a portion of every dollar they receive and then saving a portion, I showed them how they could get started investing. Afterwards, I realized I was overdue in having our kids take the next step with investing.
A little background
From the time they were super young, we taught our kids the importance of giving generously, saving consistently, and then spending—in that order. At first, we took them to a bank to make deposits. The interest rate wasn’t all that great, but that wasn’t the point; we wanted the experience of putting money in savings to be very real, very hands-on.
We’ve also had numerous conversations about investing. My thinking was that stocks would be easier to understand than mutual funds, so we started there. Their interest in solar energy led each one to buy one share of Solar City. We set up custodial accounts at Capital One, only because they were offering a $50 bonus, which far exceeded the commission. Tesla then purchased Solar City, so our kids now own a fractional share of that company.
Time for a change
But now that our kids are older (9, 12, and 14), four factors are calling for a new direction. First, there’s a much more meaningful difference in interest rates today based on where you save. Second, Capital One is not an ideal place for investing because of limited investment options and higher commissions than other brokers such as Fidelity, TD Ameritrade, and Schwab. Third, our kids now better understand how mutual funds work and the importance of diversification. And fourth, since using computers is part of their daily experience, it seems fine to move away from the experience of going to a physical bank and take things online instead.
My first upgrade was going to be helping them switch their savings account from a local bank to Capital One, which pays a respectable 1% interest rate (well, respectable compared to brick & mortar banks that are still paying .01%!). However, I think we’re going to open a custodial account at a broker where their “savings” account will be in a money market fund (MMF). Some such funds are paying more than 1.5% and using an MMF at a broker will make it easier to move money into their investment accounts.
The ideal broker for their new custodial accounts will require no minimum opening amount and will enable us to invest as we want to at the lowest cost.
It looks like Schwab will best meet our needs. It offers both custodial Roth IRA accounts and taxable custodial accounts with no fees and no opening minimums, low commissions, and a wide variety of investment choices. For savings, its Value Advantage money market fund (SWVXX) is paying 1.7% and requires just $1 as an opening investment. While I’d like to see each of our kids have a Roth IRA, only our oldest qualifies right now since only he has enough earned income (babysitting money).
The other two will have to start with a taxable account, but that shouldn’t be a problem since IRS rules and regs say they can earn $1,050 without owing taxes.
When you’re young, be aggressive
While they’ll certainly have a say in how their money is invested, I’m going to encourage our kids to be aggressive. Initially, that may mean purchasing shares of a small-cap value fund (the category advisor Paul Merriman calls The Gold Ring of Investing), such as SLYV, which they can purchase commission-free at Schwab. One share currently goes for about $134.
Once they have a large enough account balance, I’m going to encourage them to follow Sector Rotation, the most aggressive strategy offered by Sound Mind Investing, my day-job employer. The strategy objectively monitors the momentum of a relatively small universe of highly focused sector funds and selects the highest momentum fund to invest in. Over time, when that fund’s momentum score falls below the top quartile of funds in the universe, it is sold and replaced with the then current highest-momentum sector fund.
Since 2009, the strategy has required a total of 10 trades. Five of the recommended funds have traded on an “NTF” (no transaction fee) basis at Schwab. Also, four of the 10 funds have required minimum investments of $4,000 to $15,000, depending on which broker you use. However, Schwab has offered each one for just $100.
While Sector Rotation can be very volatile, it has also generated remarkable returns. Since it was launched in November 2003, the strategy has generated an average annual return of over 17%.
Consider this. If a child had $3,000 in an investment account at age 16 and generated an average annual return of 17%, by the time they were 70, their account will be worth over $14 million! And that assumes they never added another penny to the account.
Sure, there are some aggressive assumptions there, like that 17% average annual return. But even ratcheting that down to 14% would leave them with $3.5 million. But there’s also a conservative assumption built in—not contributing any more to the account after age 16. There’s no reason to stop contributing.
The main point is that time is one of the most important ingredients for investment success.
As I told the middle school students, if they will develop the habit of giving the first 10 percent of all the money they receive to a cause they believe in (it was a public school, so I couldn’t be overt in quoting Scripture), saving 50 percent—and once they have a base of about $500 in savings, redirecting that 50 percent toward investing—and if they will continue those habits when they’re older (switching from 10-50-40 to 10-10-80 to account for their “grown up” expenses of insurance and groceries and such), they will be on track toward a very meaningful, successful experience with money. In fact, it will be very close to inevitable.
Ready for launch?
We haven’t executed any of this yet. My wife and I are still talking it over and we just started talking with our kids about these specific ideas.
What are your thoughts on this plan? How have you gotten your kids involved in investing?