Warren Buffett is one of the richest people on the planet. Do you think it’s because he is the smartest guy around? Perhaps he has insider trading tips?
It’s possible. But one thing he has on his side for sure is TIME! He is old as dirt and has had PLENTY of years to grow his fortune.
Let’s say your kid starts investing when they are 1 year old. Imagine how rich they would be by the time they are 92!
The reason for this is a magical phenomenon called compound interest. Compound interest is the addition of interest to the principal sum of a loan or deposit. In other words, interest on principal… plus interest. It is the result of reinvesting interest or adding it to the loaned capital rather than paying it out.
For instance, let's say you have $1000 and you are earning 10% compounded annually. The first year you earn $1100 bucks. Now here’s where the magic comes in… the following year you are not earning 10% on that same $1000 bucks. You are now earning 10% interest on last year's $1100! Now you have $1210 bucks. And it keeps growing and growing… and growing!
Check out this chart of how far $100 bucks compounded annually at 10% will get you in 30 years.
If you do absolutely nothing and just leave your $1000 invested you will have $120,000 dollars by the time your kid is 50.
Now imagine if you contribute $1000 additional each year until your kid turns 18 to this fund. That’s less than $100 a month. Check out their net worth at 50.
Now the only thing left to figure out is where to invest this money for your kid. There are TONS of investment options out there. Real estate, stocks, crypto… even fine art!
For the sake of ease and simplicity, we suggest you start with the stock market. A safe and reliable investment in a low-cost index fund.
The index of choice in most cases is the S&P 500. It’s a useful proxy, but it has only been around since 1957. Fortunately, you can use data from Nobel Prize-winning economist Robert Shiller to approximate the S&P 500.
Using Shiller’s data, since 1971 the S&P 500 has delivered an annualized return of 7.58%—or 10.51% with dividends reinvested.
Investors who keep their money at work in the S&P 500 have been able to enjoy an annualized stock market return of around 10% over the long haul. Perfect for our model!
That doesn’t mean you can expect a 10% return every year. In some years stocks are up, whereas they fall in others. An annualized return is just an average earned over a period of time.
Several brokerage firms allow you to open custodial accounts. Check these out and pick which one you like best.
- Best Overall: Charles Schwab
- Best for Mutual Funds: Vanguard
- Best Robo Advisor: Acorns
- Best Educational Resources: Loved
- Best Custodial Bank Account: Ally Bank
The most important thing is don’t wait! The sooner you open an account for your kid the sooner he gets to take advantage of compound interest and the sooner he gets rich!