Fund Investing for Kids

Ultimately, there's no better way for kids to learn about investing than by doing it themselves, whether it's with money they've saved on their own or money given to them by a parent or other relative. Traditional tools such as summer jobs and savings accounts are still important, but mutual funds can also be an excellent way for older kids and teenagers to learn the value of a buck. Not all mutual funds are right for young investors, but with a little thoughtful research it's possible to find some that kids can feel at home in.

What to Look For
Broadly speaking, when helping kids invest in mutual funds, it's best to keep things simple. Focus on stock funds rather than bond funds, because kids have very long time horizons and can take on plenty of risk. Large-cap stock funds are generally best; not only should they form the core of any long-term portfolio, but they're more likely to hold stocks of which the kids have heard. Kids will generally have no need for sector funds or other niche funds.

Young investors generally don't have a lot of money to throw around, so a fund that requires $5,000, $10,000, or more up front is effectively closed to them. There are plenty of funds with minimum initial investments of $1,000, $500, or even $250, making them much more welcoming for beginners. You can use Morningstar's Premium Fund Screener to find funds with low minimums in addition to any other criteria you want. You might want to eliminate load funds; some of them have low minimums, but they're not appropriate if you're going to make lots of small purchases, as kids probably will.

Often it's possible to start with an even lower initial investment--sometimes as low as zero--if you set up an automatic investment plan, in which you arrange to automatically add a certain amount (such as $50) to the account each month. This can be a good option for kids with jobs that provide a regular income; not only does it allow them to start investing without a lot of money to start, but it will teach them how quickly that nest egg can grow when additions are made regularly. You can find out whether a fund has an AIP (many do) by looking on the Purchasing Information page of its Morningstar report, and you can also use the Premium Fund Screener to screen for funds with AIPs.

Low expenses are a feature any fund investor should look for, and you'll be doing kids a favor if you instill in them early the importance of fund costs. This can be trickier than it seems at first, because the cheapest funds can sometimes have high minimum purchases; still, kids can't go wrong if you steer them toward low-cost funds whenever it's feasible. Morningstar's free Mutual Fund Screener lets you screen for funds with expense ratios below their category average, and the Premium Fund Screener allows for more-detailed expense screening.

Finally, it's often considered kid-friendly for funds to avoid alcohol, tobacco, gambling, or pornography stocks, because some parents or grandparents might not feel comfortable having kids investing in such businesses. USAA First Start Growth (NASDAQ: - ), which is explicitly geared toward kids, has always had such restrictions on its portfolio. This is a more personal standard than the other ones above, and it is one that parents might want to discuss between themselves and with their kids. If you do decide that you'd like a fund that screens out certain kinds of stocks, you can use Premium Fund Screener to find socially responsible funds, most of which at least shun alcohol and tobacco stocks. However, you'll also need to look at each fund individually to see whether its standards are ones with which you agree, because funds can differ greatly in their definitions of "socially responsible" investing.

With all this in mind, here are some funds to consider if you have a child or teenager who's dipping his or her toe into the waters of investing. Of course, these aren't the only kid-friendly funds out there; judicious use of the screening tools mentioned above can help you find other candidates fitting the criteria that are most important to you. However, this list provides a good starting point for young investors.

Vanguard STAR (NASDAQ: - )
If you want to teach kids about the importance of low fund expenses, there's no better place to start than Vanguard. Some of Vanguard's most popular funds (such as 500 Index (NASDAQ: - )) are geared more toward older, more experienced investors, but Vanguard STAR is a good option for beginners. It provides exposure to 11 different Vanguard funds of various asset classes, including significant foreign exposure, and its track record is outstanding. A major factor in that good track record is the fund's rock-bottom 0.35% expense ratio. It does require a $1,000 initial investment, with or without an AIP, but nearly all other Vanguard funds require at least a $3,000 minimum, making this the best entree into this world-class family of funds.

Pax World Balanced (NASDAQ: - )
This is one of the best socially responsible funds out there, with a strong long-term track record and reasonable expenses. It also has a very low $250 minimum initial investment, whether or not you set up an AIP, making it an attractive starter fund. The fund keeps 25% to 45% of its assets in bonds, which makes it a bit conservative for most kids' needs, but it also provides significant mid-cap and overseas exposure, which can be hard to find in socially responsible funds.

T. Rowe Price Spectrum Growth (NASDAQ: - )
This fund of funds is a good way to obtain diversified, actively managed stock exposure. It invests in nine different T. Rowe Price equity funds ranging from small to large cap, value to growth, and domestic to international, and it has compiled one of the best long-term records in the large-blend category. Plus, like all T. Rowe Price funds, it's friendly to beginning investors; you can start an AIP with just $50 to start and $50 per month after that.

Ariel Appreciation (NASDAQ: - )
This fund has struggled lately, but we have enough confidence in veteran manager John Rogers that it remains an Analyst Pick in the mid-cap-blend category. Rogers avoids tobacco, firearm, and nuclear-energy stocks and prefers firms that are environmentally friendly and cultivate diversity. It's also an easy fund for youngsters to get into; you can set up an AIP with no money up front and $50 a month thereafter. On top of all this, Ariel maintains a number of educational initiatives to help disadvantaged young people.

David Kathman, CFA does not own shares in any of the securities mentioned above.