How Custodial Accounts Can Help Your Kids Learn About Investing

Imagine if you could teach your children the basics of investing, they might have an important leg up when they become adults. What you teach them could pay off in dividends—literally.

They could gain more confidence by knowing the difference between stocks, bonds, mutual funds, and exchange-traded funds (ETFs), as well as  the difference between a 401(k) and an individual retirement account, or IRA. This information can help them throughout their adult lives, even into retirement.

One way to start teaching your child about investing is through something called a custodial account.

What is a custodial account?

A custodial account is a type of savings account that lets you put money away for your children. You can contribute to it until your child reaches adulthood, which is between 18 and 21 years old, depending on state law. Once you’ve funded the account, you can invest the cash just like you would in any other investment account, in stocks, bonds, mutual funds, and ETFs.

Learning how to invest could help both you and your children have a more secure financial future

Here’s something important to keep in mind: Once you’ve set up a custodial account for your child, and it’s considered a permanent gift to the child, and they own it and control it once they become adults. In other words, you can’t take the money back—it’s your child’s money the moment you set up the account.

If you decide to pull money out of the account, it must be for the child’s exclusive benefit and not your own. That means you can’t use it to pay for things like the family grocery bills, rent, or a family vacation.

You can use the money in the account to pay for educational expenses, tutoring or computer equipment, for example.

Another potential use for a custodial account could be to teach your child about investing.

Why custodial accounts can help teach teach your kids to invest

Think of a custodial account as a set of training wheels that can get your kids excited about the world of investing. With a custodial account, you can teach them the difference between a stock and a bond, a mutual fund and an exchange traded fund, or ETF. You can also teach them about what returns are, and how to diversify. For example, they can help you choose the stocks of companies they’re excited about and influence their daily lives, which could include Apple, Disney, Facebook, or Nike.

Important lessons

Your children can check these stocks periodically, and see how they perform over time. While they might see stocks go up, they’re also likely to see them go down. That can spark a discussion between you and them about how the investing road is not always linear—it gets bumpy, and sometimes they may even lose money.

Remember, investing with a custodial account holds the same risks as investing with any other account. Your investment may go up or down, depending on the markets.

Furthermore, custodial accounts are considered an asset for your child. That could interfere with his or her ability to get financial aid, according to the Financial Industry Regulatory Authority (FINRA).

What if I don’t know how to invest?

You might be thinking:  “This is great, but I can’t help my child invest, because I don’t even know how to do it myself.”

Fair point. But that doesn’t mean you can’t learn. The basics of investing may seem really complicated on the surface, but they aren’t rocket science. All it takes is some studying up on your part so that you’re prepared to teach your kid.

You can find good introductory investing books at your local library, and you can listen to investing podcasts and video blogs, or read through Stash’s Learn archives to find out more.

Learning how to invest could help both you and your children have a more secure financial future.