John Bogle, the founder of Vanguard asked one of his teenage granddaughters who spent a few months with him and his wife, working a summer job about whether she liked it or not. “She said, ‘I liked it, but I didn’t learn anything,” said Mr. Bogle. “I said, you’ve learned all you needed to know. You learned to get to work on time. You learned to do an honest day’s work for an honest day’s pay. You learned that sometimes bosses are unreasonable and sometimes the customer is wrong but you have to pretend they’re right.”
Besides those benefits explained with such remarkable set of words, studies also show that teens who work part-time while in school are generally more focused and structured and are better stewards of their time. And they do better at school. 10-15 hours a week of part-time work is the ideal recommendation beyond which it starts to have an impact in other aspect of their lives.
So work is good and work means pay and pay means that your teen now can splurge on whatever her (a bit partial, you know) heart desires. Or knowing what she knows because she happened to attend a few of my boring lectures (PrepDojo…in perpetual beta but someday…), she can bank that pay and if you have the resources to help, you can replace whatever she banks to make sure she does not feel deprived. But even if you can’t, so what. A bit of deprivation don’t hurt no one.
But just banking that pay is not good enough. What’s better? Investing. Especially for that teen with decades and decades of compounding staring ahead at her. And stock market is usually a preferred route to deploy those savings into.
So you nudge her towards opening a brokerage account and help her divert those savings into that account and buy shares in say Disney. Disney as you know pays a dividend each year. Dividend means income and income means taxes and though her tax bracket is low now, with the path that she is on, that tax bracket is going to creep and creep up it will. But there’s a way to avoid paying any taxes at all. Forever. How?
Roth IRA. Provided your teen has legitimate earned income (you paying her to do household chores does not count), she can take those earnings and open a Roth IRA (under 18 requires a custodial Roth though). And we know the drill. Money goes in post-tax and grows tax-free and can be withdrawn tax-free. The max she gets to contribute to a Roth is $5,500 this year. That’s either going to stay the same in future years or likely to grow.
So how can you set your teen up to be financially independent at an age when most people are just starting to think about that? Say at 15, that teen of yours earns $5,000 and being a good steward of both her time and money and with a bit of your help ($$), she takes that amount and plows it straight into the Roth. If the markets do over the next many decades what they have done over the past many, then that single $5,000 investment would turn into $586,000 by the time she turns 65. That is 50 years of compounding and all of that tax-free. Granted, that is 50 years of not seeing and touching that money but what happens in the meantime. That work ethic and that habit to save instilled in her during her teen years will likely continue into the 20’s and possibly 30’s. And let’s assume it does and that $5,000 contribution to Roth is made each year for the ensuing 25 years (your teen is now 40) in a market portfolio. That’s $5.86 million at 65. Inflation adjust that and that’s a very respectable $1.5 million in today’s dollars.
And at 40, your teen who is now a grown adult with a toddler or two in tow, can de-focus from needing to save for retirement and focus on other more important and fun aspects of her life. Take on a lower-paying and a less stressful gig? She has the freedom to choose that. Become a single-income household from a dual one? There is an option for that. Take a few years off, reconvene and start over. There is that possibility.
So where and how do you invest? I say you split those savings into two piles; the bigger pile goes straight into a market portfolio – a diversified basket of global stocks. The second and hopefully a smaller pile goes into shares of businesses your teen intuitively knows, has an interest in and can learn about them over time. This is like getting a mini-MBA and she has all the incentives to learn about how businesses are born, how they grow, how to estimate their intrinsic value and what causes them to flounder and ultimately die. She has incentives because it’s her hard-earned savings at stake. And you don’t know where that could lead. Maybe she runs her own business someday or at the very least, appreciate what it takes for a business to prosper in this rapidly changing world.
Some of this business valuation stuff is again covered in those boring lectures of mine so if you have a teen that is ready, I am ready.
Image credit – Pixabay