How I Explained the Power of Investing Early in the Stock Market to My Kids

Last week I called a 15-minute “meeting” with my 2 daughters (10 years old) and my godchild (12 years old). 

Topic: Investing in the Stock Market.

They entered the meeting (living) room with straight faces that I interpreted as “Is this really necessary? Can’t we kids just have fun during the summer holiday? Djeeezzz.”

My goal: convince them to invest their savings in the stock market. 

I knew I had no chance to achieve this goal if I would let my enthusiasm on this subject take control and go into too much detail.

What I needed was simple, powerful, compelling language.

I started with the first part of the meeting topic ‘Investing in the stock market': Investing.

Investing versus consuming

I explained they can either spend their money on consumption, by buying things like toys or candy.

As you can spend every dollar only once (the same is true for Euros) spending money means that this money is gone and will never come back. 

They'll get a short-term thrill that comes from getting something new. But by the time they come home from the shop that thrill is typically already gone, together with the money. 

Alternatively, they could invest their money in assets, like real estate or stocks, that return a yield and that make it possible to turn $100 into $200 over time. 

By deferring the gratification, resisting the short-term thrill, and being patient they can have more money in the future. 

I noticed I was getting some attention. 

They were coming closer to see what I was scribbling on my paper to make my point. 

Time to move on to the second part of ‘Investing in the stock market’: Stocks.

What does it mean to own stocks?

I moved on to explain that the asset class with historically the highest returns are stocks and I tried to explain in a simple way what it means to own a stock.

A stock is a piece of a business, meaning that when you own a stock you are entitled to a fraction of all future earnings this business generates. 

I gave some examples of businesses they know, like Coca-Cola and Nike.

I did not mention words like dividends, reinvesting, growth vs value, P/E ratio, or taxes.

How much more will we get in the future, by investing in stocks? 

And now we get to the interesting part. 

I explained that historically stocks (for simplicity, when talking about stocks or the stock market, I’m referring to the S&P 500) have yielded about 10% on average.

A return of 10% means that if you invest $100 today, you get $110 next year. 

They are not impressed.

I go on to explain that an annual return of 10% also means that their money doubles every 7 years. 

They are still not really impressed. The long-term effect of exponential growth is not really an intuitive concept for the human brain. 

So I plot this on a timeline for them.

My daughters, age 10, have about $5000 in savings. This is money they got from birthdays and the like. 

Applying the historical S&P 500 return of about 10% per year, their money would double every 7 years:

Age 10: $5.000

Age 17: $10.000

Age 24: $20.000

Age 31: $40.000

Age 38: $80.000

Age 45: $160.000

Age 52: $320.000

Age 59: $640.000

Age 66: $1.280.000

With the money they already have saved today and by doing literally nothing they would have more than $1M by the time they retire.

This shows the importance of time and patience to let the wonders of compounding do their work. These kids have a limited amount of savings right now. Yet even without beating the market, the many years they have ahead of them give them the prospect of amazing results.

Here is where my godchild says: “OK I want to do this and I will buy you dinner when I have a million”🙂.

Just for a visual illustration of the power of compounding at a 10% return over time, the graph below shows the performance of $100 invested in an S&P 500 index fund in 1963, covering a time span of 60 years. The returns assume that all dividends are automatically reinvested.

If you invested $100 in the S&P 500 at the beginning of 1963, you would have about $37.517 at the end of 2023. Source.

How do we do this? 

They are all three asking me, ‘How do we do this?’, ‘Can we do this right now?’, ‘Can you show me?’.

I explain that instead of buying a couple of companies like Nike or Coca-Cola, they can also buy a broad basket of stocks with Index funds or ETFs (Exchange-Traded Funds). 

Doing so, they will get the stock market return (the 10%, or whatever it may be in the future) and they don’t need to worry about whether people will continue to drink Coke (I’m sure they will) or wear sneakers (I’m sure they will).

Finally, we review some broad, low-cost, accumulating ETFs together they could buy.

By the time I write this all three kids have their savings invested in broad low-cost ETFs. Mission accomplished!

Some final thoughts and nuance

If those 3 kids want their savings to compound to over $1M by the time they retire, they will need one skill: patience. 

It's important to understand that investing in stocks is a long-term game and they shouldn’t get discouraged if the stock market goes through a downturn. 

Of course, they can sell these ETFs whenever they want, and they will have plenty of good reasons for that, like buying a house or having kids that need to go to college.

I just think it’s important that they know that investing early and letting time and compounding do its wonders is an option that is available for them. Up to them to use it or not.

I do think that working toward financial independence is not a bad idea, as this can give you the freedom to do what you are passionate about, but I also think there is more to life than saving and waiting to have more later ...

... and that’s why after our 15-minute meeting I took my class out for some money spending and some short-term thrill 🙂