Should You Buy Stocks For Your Kids?

If you’re a parent, how can you set your child on the road to investing success?

One popular way is to buy young kids shares in companies familiar to them—maybe Disney, Apple, or McDonald’s. The idea is to get them excited about owning businesses that make their favourite products and services, with the hope that will turn them on to investing. I’m sympathetic to this idea, and it may work for some families—I’m certainly not trying to be a judgmental parent here. But I do wonder whether the best way to teach young people about investing is to turn them into stock pickers. I’ll offer three arguments against it:

It’s the wrong priority. On the list of key ingredients in an investment plan, picking the right stocks (or funds) isn’t even in the top five. At the top of the list is a commitment to regular saving. After that comes choosing the appropriate risk level for your goal, diversification, low cost, and minimizing taxes. Focusing on the stocks themselves is emphasizing the wrong part of the process. It’s like teaching your child to play hockey by buying him a cool stick rather than showing him how to pass, shoot and backcheck.

Many people take for granted that successful investing is all about choosing the best investments. But as Carl Richards point out, “searching for this best investment leads to behavior that ends up costing us money.” If we want to teach our kids about investing, isn’t it better to help them understand this as early as possible?

It encourages “home team bias.” Your familiarity with a company has no bearing on whether it’s a good investment. If you’re going to teach your child to be a stock picker, at least help her understand that point. Explain that loving the Toy Story movies, or her iPad, or Chicken McNuggets is not a reason to invest in shares of those companies, because the market doesn’t care about her personal preferences. Buying your favourite companies is the investing equivalent of cheering for the home team.

I’m glad my parents didn’t buy me stocks in the companies I knew and liked as a kid. I was proud of the Kodak camera I bought with money from my paper route, my favorite car was GM’s Corvette, and when my mom shopped at Eaton’s she used to buy me ice cream at the nearby K-Mart. It’s only with the benefit of hindsight that you can second-guess investing in these once blue-chip companies that later went bankrupt. If you love your BlackBerry, you should have no problem making this point to your child.

It can be impractical. A portfolio with a small number of stocks is not only poorly diversified, but unlikely to be cost-effective for a young investor. Discount brokerage accounts with small balances often carry account fees and high trading commissions, and even if you’re paying $5 or $10 per trade, that can quickly add up. (Remember, regular contributions are something you want to encourage.) Using DRIPs in a discount brokerage account is also impractical if you own a small number of shares, and direct stock-purchase plans strike me as a lot of paperwork for a new investor to manage.

A different way to invest with kids

I’ve heard people recommend that young investors build their portfolio one stock at a time, but I think this gets it exactly backwards. People with small sums are ideally suited to index mutual funds, which have no trading fees, instant diversification, seamlessly reinvest all dividends, and are perfectly suited to automatic contributions. When you’re just starting out, fund MERs can be very small in dollar terms: even 1% on a $5,000 account is just $50 a year, a small price to pay for establishing good habits. If your child eventually wants to pick individual stocks, that should come much later, once these benefits become less important.

So what do I recommend? The ING Direct Streetwise Funds are probably the easiest solution, since there are no account fees, no transaction costs, no minimums, automatic contributions are simple, and your child can manage the account online without having to open a brokerage account. If you have a relationship with TD Bank, an e-Series account is easy to maintain, even if it can be an ordeal to set up.

Other options may be a better fit with your family, and perhaps that will include some individual companies. I’d just encourage parents to make sure their child isn’t left with the impression that successful investing is about picking stocks.