But if you think about it, stepping out into the world with just the clothes on your back is pretty scary and very risky. You have no room for error, since you have no safety net there to catch you if you lose a job or just have an unexpected expense. Many families also don't talk about money, which leaves young adults needing to figure things out for themselves with no training. Unfortunately, many kids today seem to think they can step into their parent's lifestyle immediately, not realizing all of the work and time it took for their parents to be where they are. By starting children out early learning about saving and investing, and by giving them a little nest egg with which to start, you can dramatically reduce the chances that they will be knocking on your door, duffel bag in hand after college. Without another safety net, Mom and Dad become the safety net by default.
Starting an investment fund can be very quick and easy, especially if you use index mutual funds. If you start a fund about the time the kids are born, add to it as they get those checks from relatives early on, and then match their contributions once they start to earn their own money, you can build up a substantial fund by the time they leave the house. This is money they can then use when they have the unexpected expenses that always occur instead of running up credit card debt. It can also provide rent payments for a couple of months after a job loss.
The first step in building this safety net is to find a fund family with a low enough minimum to allow you to open the account using the free cash flow that you have. I personally like Vanguard because their funds have very low expenses and the minimums for many of them are only a few thousand dollars.
In selecting which fund to buy, you are looking for a fund that invests in a large number of stocks over a broad range of the market. Good choices would be a largecap fund such as an S&P500 fund or a midcap or smallcap fund. Selecting specific sector funds or ETFs is probably not a good idea since you want something you can hold for years rather than needing to move in and out of it, incurring capital gains taxes.
Once you have selected a fund, simply create a custodial account in the child's name and send in a check. As time passes, add extra money to the fund. You should avoid the temptation to make many if any changes or move money from fund-to-fund or into and out of a fund. You want to minimize expenses and taxes, plus you might be in cash right when the market makes a big move up if you try to time the markets. Just let it grow with the economy. If you need to do something, wait for dips and buy more shares.
Once the fund has grown large enough, you should consider selling part and using the proceeds to buy another fund in a different sector of the market. For example, if you've amassed $15,000 in a large cap fund, you may want to sell half and buy a small cap fund with the proceeds. This diversification will reduce the risk of losses and smooth out the fluctuations that occur. In general, different sectors of the market do well at different times.
Note that capital gains and dividends will be tax-free below a threshold amount, but be sure to check with your accountant on what those minimums are in any given year. They are generally less for investment income than earned income. You may also need to file tax returns in some years if the income is large enough even when they haven't made enough to pay taxes. Payment of quarterly estimates may also be required. Minimization of trading, and thereby the realization of gains, will delay the time at which you will need to start preparing tax returns for their accounts.
Once the child reaches 18, the money will be theirs (you have no say over this). You therefore should be teaching them the importance of managing the money so that it grows by leaving the principle alone and just spending a portion of the interest/dividends. You can perhaps let them spend a small portion of the profits, but allow the rest to be reinvested and grow the account, so that they can see that their income will increase each year this way. Explain that if they start spending the principal, the income they can receive will decline and eventually the money will be all gone. Also teach them along the way that the money is there to help them in emergencies, such as when the car breaks down, and not just for day-to-day expenses. Talk about what would happen if they had an emergency but had no money available, versus what would happen if they keep money aside. Explain that going into debt means that they will be working extra hours just to pay interest rather than getting money from investments without needing to work for it.
Even given the best advice. they may make mistakes while they are young and foolish. Think about holding a bit of money back and giving it to them when they are a bit older. In this way you can give them a second chance should they fail the first time.
By giving your children a nest egg with which to start their lives, you can help keep them out of debt, help them have a down payment for a house when they are ready, and be able to stay out on their own between jobs and other issues. You will also give them an extra source of income that they can use throughout their lives.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.