Investing for Teens: Why Index Funds Are a Great Place to Start
One of the most important things we can teach our kids about investing is that building wealth doesn’t have to be complicated.
Teens seem to be naturally drawn to investing. There’s a thrill to picking a stock, watching the price move, and wondering if you’ve found the next big winner.
But if you’re like me, that thrill can also be a little intimidating.
The good news is that successful investing doesn’t have to mean picking individual stocks, watching the market every day, or trying to figure out exactly when to buy and sell.
In fact, one of the simplest ways to invest is also one of the most powerful: index funds.
If your teen understands what an index fund is, why diversification matters, and what can happen when money is given decades to grow, they’ll already understand something many adults wish they had learned much earlier.
So parents, read this one first. Then pass it along to your teen.
What is an Index Fund, Really?
An index fund is a way to invest in a group of companies without having to choose each company yourself.
One of the best-known examples follows the S&P 500, an index that tracks about 500 of the largest publicly traded companies in the United States.
So let’s say you invest $500 in an S&P 500 index fund. What do you actually own?
You own shares of the fund, and the fund owns stock in all of the companies in the S&P 500. So your $500 gives you indirect ownership in companies like Apple, Microsoft, Amazon, Walmart, and hundreds of others.
Your money isn’t divided equally among them. Larger companies make up a bigger portion of the S&P 500, so more of your investment is tied to them.
Of course, there is still risk. The stock market goes up and down, and so will the value of an index fund. But over long periods of time, the U.S. stock market has historically trended upward. And because an index fund isn’t dependent on the performance of a single company, the ride is generally less volatile than owning just a few individual stocks.
You invest, keep investing over time, and give your money time to grow.
Simple. But there’s a lot of power in that simplicity.
The Advantage of Index Funds
So why not just pick your own stocks?
You can. And there’s definitely more excitement in finding a company you think is going to take off and watching to see if you’re right.But consistently picking the winners is harder than it looks.
Think about the latest “hot” company everyone is talking about. By the time you hear that it has an amazing new product, sales are booming, or it’s expected to grow like crazy, thousands of professional investors have probably been studying that company for months. They’ve already bought the stock, and all that excitement has helped push the price higher.That doesn’t mean the stock can’t keep going up. It absolutely can. But the giant jump that made everyone start talking about it may have already happened. In other words, knowing a company is great isn’t the same as knowing its stock is a great buy at today’s price.
That’s where index funds have a huge advantage. You don’t have to figure out which companies are going to outperform everyone’s expectations.Remember your $500? Invest it all in one company and you’re depending heavily on that company to do well. Put it in an S&P 500 index fund and your money is spread across hundreds of companies in many different industries.
That’s diversification.
Some of those companies will have fantastic years. Some will struggle. And over time, the companies making up the index will change too. You don’t have to know today which ones will become tomorrow’s winners.
Even Warren Buffett, who became one of the wealthiest people in the world by being exceptionally good at choosing investments, has long recommended a low-cost S&P 500 index fund for most investors. He has even instructed that 90% of the money left for his wife be invested that way.I think there’s a pretty good lesson in that.
You don’t have to be great at picking stocks to be a successful investor. In fact, picking the perfect stock may matter a whole lot less than two things that are completely within your control: starting early and investing consistently.
And if you’re a teenager, you have a huge advantage when it comes to the first one.
Time.
The Power of Time
Here’s where being young gives you a huge advantage.
Let’s say you have $500 to invest. You put it in an index fund and never add another dollar.If that $500 earns an average of 8% per year, after 10 years it would be worth about $1,080. Now, $1,080 after 10 years may not sound all that impressive. But remember, you didn’t do anything to earn that extra $580. Your money did.And compare that with keeping the same $500 in a savings account or money market account. If it averaged 3% over those 10 years, you’d have about $672. That’s a difference of more than $400 on just a $500 investment.
But 10 years is really just the beginning.
Leave that same $500 invested at an average 8% return for 20 years and it could grow to about $2,330. After 40 years, about $10,860. And after 50 years, more than $23,000. You never added another penny. That’s the part I want you to notice. Time becomes more powerful the longer you give it.
Of course, an 8% return isn’t guaranteed. The stock market goes up and down, and there will be years when your investment loses value. That brings us to one of the most important rules of investing: Don’t invest money you’re going to need soon.
If you have $500 saved for a car you plan to buy next year, that $500 does not belong in an index fund. The market could drop right before you need the money, forcing you to sell your investment for less than you put in.
Your car money, money for a trip next summer, or anything else you expect to need in the next few years should be kept somewhere safer, like a savings account or money market account. You won’t have the same potential for growth, but that isn’t the job of that money. You need it to be there when you need it.
Investing is for money you can leave alone for a long time.
You can do it now!
You don’t have to wait until you’re an adult to start investing.
If you’re under 18, you generally can’t open a regular brokerage account completely on your own. But a parent or other adult can open a custodial brokerage account for you. You and your parents can choose to work with a financial advisor who helps manage the account for a fee, or use a brokerage where you choose and manage the investments yourselves without paying an advisory fee.
Once the account is open, you can use the money to buy an index fund. And you do not need a job or earned income to invest through a regular custodial brokerage account.If you do have earned income, you may also be able to contribute to a custodial Roth IRA. Roth IRAs come with their own rules, so we’ll save those for another day. For now, just know that working teens have another investing option worth exploring.
You also don’t need a huge amount of money to begin. Depending on the brokerage and the fund, you may be able to start with $50, $100, or whatever amount you have available.But remember the rule we just talked about: only invest money you won’t need for a long time. The $500 you’ve saved for a car next year shouldn’t be invested. Neither should money you’ll need for a trip this summer or a new laptop in six months. That money belongs somewhere safer.
So how much should you invest, and how long should you plan to leave it invested? That depends on your particular goals and when you’ll need the money. Talk through those questions with your parents or with whomever you choose to advise you. They should understand your goals and timeline before helping you decide how much belongs in savings and how much you can afford to invest.
The important thing is not to assume investing is something you have to wait to do until you’re older and earning a big paycheck. You can start small. You can get help.And you can start investing now.
Wanna practice before it’s real?
In Lesson 14 of Beyond Personal Finance, you get to put our investing lesson into practice.
By this point in the simulation, you’re 36 years old and, hopefully, you’ve accumulated some money to invest. You’ll choose from several different investment options and decide how much you want to invest.Over the next six lessons, you’ll watch the value of your investments rise and fall as the years pass. You can add more money along the way, or decide it’s time to sell.
Just like everything else in Beyond Personal Finance, you make the choices and live with the results. And the best part? You get to practice with pretend money before your own money is on the line.
Frequently Asked Questions
What age can a teenager start investing in index funds?
Teens don’t have to wait until they’re 18 to start investing. A parent or other adult can open a custodial brokerage account for a minor, and the money in that account can be invested in an index fund. The adult manages the account until the teen reaches the required age to take control, which varies by state and account type.How much money does a teenager need to start investing?
You don’t need a lot of money to get started. Depending on the brokerage and the index fund, a teen may be able to invest $50, $100, or even less through fractional shares. The more important question is whether you’ll need that money soon. Money saved for a car, trip, laptop, or another short-term goal should generally stay somewhere safer. Only invest money you can leave invested for the long term.Are index funds risky for teenagers?
Yes, index funds have risk because they are invested in the stock market. Their value will rise and fall, and you can lose money, especially over shorter periods. But an index fund spreads your investment across many companies, so you aren’t depending on the success of just one or two. Historically, the U.S. stock market has grown over long periods of time, which is why index funds are generally better suited for long-term money rather than money you’ll need soon.
About Beyond Personal Finance: Beyond Personal Finance gives teens (middle & high school) the chance to design their future to see if they can really afford the life they dream of. In one semester (20 lessons- less than 2 hours per lesson), your teen will choose (and budget for) a career, car, apartment, spouse, house, investments, and so much more. This is the class your teen will get excited about. We also provide a curriculum called Before Personal Finance for tweens. Before Personal Finance is designed for late elementary students (Ages 8-12) and introduces foundational money concepts—spending, saving, investing, and borrowing—in a way that’s imaginative, hands-on, and fun. Learn about our full offering of services at beyondpersonalfinance.com!