Online Trading for Kids

Kids with an interest in computers and computer games probably read PC, Wired, EM2, and similar magazines. They see people in their 20s who were formerly called geeks but now are creating the fastest-growing Internet companies. Kids also see how these companies have gone public and have made these young owners instant millionaires. So, the idea of the stock market isn't an unfamiliar one to many kids. In fact, Wired has started tracking its own stock index made up of many so-called tech stocks, such as Dell Computer and AOL, but also stocks for the next century as well, including Walt Disney, Sony, and Wal-Mart. Ask a young subscriber, and he's probably familiar with these companies—he may even follow the ups and downs of the index in the magazine each month.

Kids today are now using computers for two key investment activities:

• Making trades. The process is quick and direct, and the commissions for online trading are less than those charged for making conventional trades. For example, Charles Schwab charges less for its online trades than it does for its conventional discount brokerage trades. Some online firms, such as Ameritrade, charge a flat, modest fee no matter how many shares are purchased or at what price. Online trading isn't limited to stocks, either: It's also possible to buy mutual funds, bonds, and other types of securities online.
• Tracking investments. Dozens of resources out there make things easily accessible and cheap. For example, instead of paying a subscription to a financial newspaper, much of the same information can be found on the Web for free.

Starting at a young age to use the computer for investment activities is a smart way to start a beneficial lifelong habit. For example, a high school child who's used to looking up stocks on the Internet can easily continue to track his portfolio when he goes off to college.

Mechanics of Online Trading

Kids can buy and sell stocks online in the same way as adults can. They can use E*TRADE, Charles Schwab Online, or many other companies offering online trading. The only catch: For children under 18, the account must be set up as a custodial account, and unlike regular accounts, custodial accounts generally can't be opened online. Instead, you must request an account form (which you can do online) and then submit it by mail.

Custodial accounts are supposed to be managed by the custodian (typically that's you, the parent). Customer agreements state that only an account holder of legal age will trade online. As a practical matter, however, once the online account is in place, there's no real mechanism to prevent the kids from doing their own trading. (A broker talking to an investor won't take an order from a minor, but the computer doesn't know the age of the person who's imputing the information.) It remains to be seen whether the industry will put any controls in place to prevent direct trading by minors. For example, what happens if your 12-year-old puts in an order to buy 10,000 shares of stock in his custodial account for $1 million and then the price of the stock tumbles to half of what it was when the order was executed? Who's left holding the bag?

Without industry controls in place to prevent online trading by minors, it's up to you as a parent to monitor your child's activities. You can't help but see articles from time to time in your local newspaper about how a 15-year-old has made millions by trading online. But that's the exception (that's why it's newsworthy). Your job is to provide necessary controls on what's otherwise a very easy investing process. Here are some of the strategies you can use to avoid online trading catastrophes:

• Discuss all proposed trades that your child wants to make. You wouldn't do otherwise if you were dealing directly with a broker, so why should it be any different with online trading?
• Set up procedures in your home for making trades. For example, you may insist that only you submit orders to buy or sell (while allowing your child to monitor investments online). Or, you may have a set time each evening that you sit down with your child in front of the computer to make any trades.

Once the account is in place, a child can decide what to buy or sell. There's no broker making specific investment suggestions, so it's up to you and your child to make the stock picks. However, the same fundamentals used in investing in the conventional way (explained in The Rewards of Stock Market Investment) apply with equal force to online trading.

• Know what you're buying. Understand the risks and potential rewards of your choices.
• Take a long-term view. Don't let the ease of the online investment method spur you to make foolish decisions.

The advent of online trading is still relatively new, and all the kinks haven't been worked out yet. There are still problems to be aware of:

• The price of the stock that you see on the screen may not be the price you actually pay for stock. For example, you might put in a market order for 100 shares when you see the price at $25. By the time your order is executed, the stock has jumped to $60. You expect to pay $2,500 (besides commissions), but the bill is $6,000—more than double what you anticipated. One online company waives the commission if it doesn't execute your order within 60 seconds, but there's no price guarantee for the stock.
• You put in a market order to buy 100 shares but don't receive an electronic confirmation, so you enter the information again. Now you've actually purchased 200 shares. The same thing can happen in reverse. You might try to sell the 100 shares held in your child's custodial account, don't receive confirmation, and you try to sell them again. Now you've actually sold 100 shares you've never even owned.
• You put in an order to sell or buy but try to cancel immediately. You think you've acted before the order has been executed, or you may even have received an acknowledgment of the cancellation. The sale can still go through, though, and now you have to buy the stock you never intended to.

Some brokerage firms are trying to accommodate inadvertent slip-ups; they'll cancel these errors and make you whole again. But policies differ from company to company, so make sure you know who you're dealing with.

Here are some companies specializing in online trading:

• Charles Schwab Online (www.schwab.com)
• Lombard Institutional, a division of Discover Broker Direct of Morgan Stanley Dean Witter (www.lombard.com)
• National Discount Brokers (www.pawws.com)
• E*TRADE (www.etrade.com)
• Ameritrade (www.ebroker.com)
• Datek Online (www.datek.com)

More than 100 brokerage firms now have online trading. Many of the full-service firms, such as Merrill Lynch and Paine Webber, also offer online trading at reduced commissions.

Keeping Track of Things

How is your kid doing with his stock picks? To know this answer, your child should keep track of things. Use personal finance programs, such as Quicken, to keep records of stock holdings. Here's the type of information he'll want to enter:

• When he bought the stock
• How many shares he owns
• What he paid per share
• What he paid in commissions or other charges
• Any dividends or other distributions that are paid on the stock
• Any dividends that were reinvested (and at what price per share)

This information will let him see whether the stock is increasing in value or lagging behind what he had expected. It's also necessary to have this information for tax purposes so that he'll be able to figure his taxable gain when he sells shares.

In addition to keeping good records, your child can also use the computer to research possible new stock picks and to keep tabs on how things are doing. This is so easy that it can be done every day.

Here are just some of the ways to do research with the help of a computer:

• Newspapers online. Each day, most local newspapers and all financial newspapers publish closing stock and mutual fund prices from the day before. Many papers now have online versions designed to let investors check the same information contained in the newsprint. Some information is free; other information requires the payment of a subscription fee.
• Magazines online. Many financial magazines may not seem timely because they're published only once a month (or at some other interval). But magazines online are updated daily. For example,
• Money Magazine Online gives a daily summary of important stories on investing.
• Television programming online. Financial news can be found on many cable stations. Now it can also be found on these stations' Web sites: CNBC (www.cnbc.com), CNN Financial Network (www.cnnfn.com); MSNBC Commerce (www.msnbc.com/news/COM_Front.asp), and Bloomberg (www.bloomberg.com). In addition to news stores, these sites contain stock quotes, market reports, and other information that changes constantly. There's also weekly programs such as Louis Rukeyser's Wall Street Week on PBS (www.pbs.org/mpt/rukeyser).
• Other Internet locations. Find daily or even up-to-the-minute market quotes on dozens of sites. Examples of stock quote sites include Data Broadcasting Corporation (www.dbc. com), PC Quote (www.pcquote.com), and Quote.com (www.quote.com).

Many search engines have market quotes available. Most brokerage firm Web sites also provide market quotes. Yahoo! News (in association with Reuters) presents business news items of interest to investors (dailynews.yahoo.com/tx/bs/summary.html).

Excerpted from The Complete Idiot's Guide to Money-Smart Kids © 1999 by Barbara Weltman. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.

To order this book visit Amazon's web site or call 1-800-253-6476.