Kids and Money: Stats That Will Get Their Attention

Last Updated Nov 2, 2010 2:20 PM EDT

Kids should begin saving and investing in earnest as soon as they have wage income. It's a great idea to expose them to the markets even earlier by using gift money or allowance to buy a few stocks in their name. But once they have a job they should set something aside each pay period. It's a habit that will pay dividends for life.

I encourage my own kids to save by agreeing to match their summer earnings as long as they put most of the Bank of Dad bonus in a Roth IRA. The dollar-for-dollar match is admittedly generous. But my oldest kids are young adults that no longer receive an allowance; they are college students and their summer jobs have to stake them for a year.

I'm happy to get them started this way, and I regard the match as a valuable lesson in how a good 401(k) plan works. My hope is that this experience will lead them to enroll in such a plan at work as soon as they graduate and launch their career.

Why is it so important for young people to start investing early? If you save $250 a month in a tax-deferred account from age 22 to 32 and then stop saving, your money will grow to $1.38 million by age 65 (assuming a 10% rate of return). If you delay saving until age 32 and then save $250 every month through age 65 (and your money grows at 10%) you'll have just $856,347.

Eye-popping statistics like that should get anyone's attention. Which is why, in my last post, I mentioned The Investment Answer by Daniel Goldie and Gordon Murray. It's a short and sweet new book about how to invest with confidence. It's a great primer for young people and makes good use of revealing data to explain:

· The magic of being a Steady Eddy The stock market rose an average annual 8.2% from 1990 through 2009. Yet in the same period the average stock fund investor gained only 3.2% a year. How can that be? The average investor, it turns out, puts more money in the market when prices are up and takes more out when prices are down. The upshot: keep investing in a regular pattern through thick and thin and you'll do more than twice as well.

· The insane cost of market timing If you had invested $1,000 in the stock market in1970 and went to sleep until 2010 your money would have grown to $43,119. But if you tried to time the market -- getting out at high points and back in at low points -- and as result missed the single biggest one-day gain in the market during that long period your money would have grown to just $38,667. Miss the best 25 days and you might s well have been in a money market account the whole time. And by the way, no one can time the market with any consistency.

·The myth of good stock pickers By a landslide, most actively managed mutual funds fail to beat their benchmarks. From 2005 through 2009, 61% of large-cap funds, 77% of mid-cap funds and 67% of small-cap funds underperformed -- as did 90% of emerging markets funds. Odds are pretty good that you'll end up with a loser. Stick with index funds, which are designed to match the benchmarks.

· The advantage of low expenses Over 30 years, $1 million with an 8% average annual return will grow to $7.6 million in a fund that charges 1% annually but to just $5.7 million in a fund that charges 2% annually. Again, stick with index funds; they have annual charges of as little as .18% of assets -- by far the lowest fees in the fund world.

· The beauty of rebalancing A broadly diversified portfolio that was rebalanced once a year to maintain its target mix of stocks, bonds and cash from 1990 to through 2009 rose 8.9% a year while the same portfolio untouched rose just 8% a year. Annual rebalancing has the effect of forcing you to sell what has risen and buy what has fallen. In other words, you automatically sell high and buy low.

None of this is new information. But accessible and neatly packaged examples like these demonstrate that common sense and simplicity are the keys to successful investing, which is within everyone's reach.

It's only a nightmare if you make it one. So don't.

If you have a question about kids and money, I'll get the answer. Email me at dankadlec@dankadlec.com

Photo courtesy Flickr user wwworks.

  • Dan Kadlec

    Daniel J. Kadlec is an author and journalist whose work appears regularly in Time and Money magazines. He is the former editor of Time’s Generations section, which was written and edited for boomers. Kadlec came to Time from USA Today, where he was the creator and author of the daily column Street Talk, which anchored the newspaper's business coverage. He has co-written three books, including, most recently, With Purpose: Going from Success to Significance in Work and Life. He has won a New York Press Club award and a National Headliner Award for columns on the economy and investing.