Investing in the stock market as a teenager is one of the best ways to set yourself up for financial success. In this post, I will outline what a stock is, what causes a stock price to change, and the benefits of investing as a teenager. 

Broad definition:

A stock represents partial ownership of a company, including its assets and earnings. Stocks can be traded between investors on stock exchanges and change prices because of supply and demand.

What is a stock exchange?

A stock exchange is a place where investors buy and sell shares of a company’s stock.

For a company’s stock to be sold on a stock exchange, the company has an IPO (initial public offering). An IPO is a process where a private company sells shares to its first public investors and becomes a public company.

After a company’s IPO, investors don’t directly buy shares from the company but instead purchase shares from other investors.

Why do companies issue shares?

Companies usually decide to issue shares (go public) to raise money and awareness. This allows them to expand operations, take on new projects, and increase revenue. Note: Public company’s companies can issue new shares (increase outstanding shares) or buy back shares (decrease outstanding shares)

Why do stock prices change?

Supply and demand are what control a company’s stock price. 

If more people want to buy a company’s stock than want to sell its stock, sellers can charge more. This same principle works in the other direction. When more people want to sell a stock than want to buy that stock, the sellers will be forced to reduce their prices to compete for buyers, which causes the price to drop.

Many things influence supply and demand, such as loan interest rates, company earnings, news headlines, economic policy changes, and world events (like COVID-19.)

Dramatic changes in price

Because a stock price is driven by supply and demand, a stock’s price doesn’t necessarily reflect its value. For example, Alphabet’s (google’s) stock price dropped 30% because of uncertainty caused by the pandemic. Ultimately, investors realized that the pandemic would be good for Google because Google derives a large portion of its revenue from online advertisements, causing the stock price to reach new highs. 

On the other hand, stocks can quickly become inflated because the market over-reacts to the latest news headlines about a company.

This means that in situations where a company or ETF’s price changes dramatically, you should evaluate whether the change was justified and respond accordingly.

What is a dividend?

A dividend is a portion of a company’s earnings it pays to its shareholders, usually at the end of a quarter. However, not every company pays a dividend. Newer companies generally reinvest all of their earnings to grow their business and have no dividend. Older, more stable companies that aren’t growing very fast, like Coca-Cola and AT&T, usually use some of their profits to pay their shareholders a dividend. 

The amount of money paid as a dividend to investors varies from company to company and is referred to as dividend yield. Dividend yield is the yearly dividend payment divided by stock price (dividend/price).

For example, if you own a share of a company with a stock price of $100 and a dividend yield of 2%, you would be paid $2 every year.

Diversification 

Diversification is a way to reduce risk by investing in many companies – usually tens, hundreds, or even thousands – rather than just a few. The benefit of diversification is that when one company’s stock goes down, another company’s price going up will compensate, and overtime, the portfolio will have a more consistent upward trend.

It is important to balance risk and diversification. The fewer stocks you own, the higher potential gains and the higher the potential risk. If you own only one stock, the stock could double, but there is also a possibility the company could go bankrupt. Depending on your investment horizon, you can adjust risk accordingly.

You can diversify further by investing in other assets such as bonds, commodities, cryptocurrencies, and real estate.

Index funds and ETFs

Index funds and ETFs are the easiest way to diversify. 

“An index is a method to track the performance of a group of assets in a standardized way.” – investopedia.com

Index funds were created to allow people to invest in indexes. These funds buy shares of the company’s in the index they are tracking and then allow investors to trade shares of the fund like a regular stock. 

For example, the S&P 500 tracks the 500 largest US companies. The ETF with ticker symbol SPY buys shares of companies in the S&P 500 and allows you to own a small fraction of each of those companies. 

Why do people buy stocks?

Simply put, people buy and sell stocks to make money. However, although there are investment strategies to mitigate the risk of losing money, buying and selling stocks does carry significant risk. 

I want to emphasize that stock market investing is not a get rich quick scheme. While you may hear stories of people becoming millionaires overnight, it is almost always luck, and that person could have just as easily lost all of their money. 

The investing strategy that has been proven time and time again is to invest consistently over long periods into index funds and ETFs with proven track records. 

What are the risks?

There is always a risk that a company will, for whatever reason, lose value. However, if you invest in many different companies, putting your money into index funds and ETFs, and consistently invest over a 10-20 year period, you are almost guaranteed to make money. Particularly as a teenager, the risks of investing are low. Depending on why you are investing, maybe to eventually buy a house or even retire, you will probably keep your investments for a long time. The longer you keep your money invested, the lower your risk will be. 

Do you have to be an adult to own stocks?

You do not need to be an adult to own stocks. With the help of one of your parents you can open a custodial investment account.

“The term custodial account generally refers to a savings account at a financial institution, mutual fund company, or brokerage firm that an adult controls for a minor (a person under the age of 18 or 21 years, depending on the laws of the state of residence). Approval from the custodian is mandatory for the account to conduct transactions, such as buying or selling securities” – Investopedia.

Even though your parent or will guardian technically control the account, you own the money in the account, can make trades with the permission of your parents, and once you become a legal adult you’ll gain full control of the account.

Most major banks have an option to open a custodial account, so opening an account should not be very difficult.

Custodial accounts can be confusing, so I recommend reading more about them in my post “How to Invest as a Teenager.”

Currently, I use stockpile.com and you can click here to read a full review.

Why it’s important to start now

It’s easy to think of investing as something for adults or something you’ll start doing later. However, the earlier you start investing, you will begin to benefit from compound interest. Compound interest is an extremely important concept when it comes to making money and investing. 

“Compound interest is interest earned on money that was previously earned as interest.” – thebalance.com

For example: let’s say you invested $100 and made a return of 10% or $10. Assuming you keep this money invested and make another 10% next year, you will make $11.

This might not sound like a big deal; after all, it’s only a $1 difference. But let’s scale this up and say you start with $100 and make 10% every year for 25 years. At the end of those 25 years, you will have over $1000.

The takeaways

1. A stock represents partial ownership of a company, including its assets and earnings.
2. A dividend is a portion of a company’s earnings it pays to its shareholders.
3. A stock exchange is a place where investors buy and sell shares of a company’s stock.
4. For a company’s stock to be sold on a stock exchange, the company has to have an IPO.
5. Investors don’t directly buy shares from the company but instead purchase shares from other investors.
6. Companies usually decide to issue shares (go public) to raise money and awareness.
7. A company’s stock price changes because of supply and demand 
8. A stock’s price doesn’t necessarily reflect a company’s value. 
9. When a company or ETF’s price changes dramatically, you should evaluate whether or not the change was justified
10. Diversification is a way to reduce risk by investing in many companies.
11. A well-diversified portfolio will usually be less volatile and will have a consistent upward trend.
12. ETFs are large groups of financial assets that can be traded.
13. You do not need to be an adult to own stocks.
14. “Compound interest is interest earned on money that was previously earned as interest.” – thebalance.com

Hopefully this post help you understand the stock market and the benefits of starting to invest as a teenager. Keep in mind that I am not a financial advisor and everything I say is based on my personal experience as a teenager.