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How to Raise a Hedge Fund Whiz

My 7-year-old son asked me a question the other day.

"Daddy, what do you write about all day?"

"Well, mostly I write about investing," I replied.

"What's investing?"

"Good question."

While it's true that I make a big part of my living by explaining investment and personal finance concepts, it's one thing to explain, say, asset allocation to adults, and another thing entirely to get back to the most basic of basics with a young child.

Of course, if you have kids, teaching them the basics of investing is an important thing to do. As my fellow Fool Selena Maranjian has pointed out in the past, getting kids interested in investing is a great way to give them an edge in life. For me, as a parent, an understanding of investment basics is must-have knowledge for my children, up there with how to use a hammer and how to scramble an egg. While they won't necessarily all grow up to be hedge fund managers, a young adult with an understanding of investment basics will be more motivated to save, and will have the knowledge to make better choices in everything from a home purchase to 401(k) investments.

Mostly, though, I want them to be at ease with investment concepts and terminology. I've seen so many adults -- smart adults -- get thoroughly daunted by something as seemingly simple as an IRA. I think all financially savvy parents want to empower their children to make great financial decisions in adulthood -- and even before.

So how do you do it? Start at the beginning.

Starting at the beginning
Obviously, "the beginning" will depend on your kids. But no matter where they are starting from, it's useful to consider the ground you'll want to cover:

  • Financial goals. Here, the key point to impart is the difference between long- and short-term financial goals. For young kids, giving them an allowance is a great way to teach them the basics of money and financial goals: My Lego-addled twin 7-year-olds very quickly got the hang of "saving up" for the latest Star Wars-themed kits. Of course, saving up for a $20 Lego kit that can be acquired after a few weeks of extra chores is completely different from saving up for a bike, a car, or a down payment on a house. It's the difference between saving and investing, which leads us to ...
  • The basics of investing. Beyond "what is a stock or a bond," the key points to communicate here are about risk and reward. Where are the trade-offs between upside and downside? Some investments that may interest your kids, like Heelys (Nasdaq: HLYS  ) , may have significant downsides that will spark good discussions. Other companies like General Electric (NYSE: GE  ) may seem boring to your kids -- but have much less downside. When is boring good?
  • Follow a company together. What companies do your kids like? Lego Group, my sons' first choice, is based in Denmark and hard to follow in the U.S., but they came up with several others off the tops of their heads: McDonald's (NYSE: MCD  ) ; Walt Disney (NYSE: DIS  ) , which recently bought the online Club Penguin game they love; and Jarden (NYSE: JAH  ) , which, we discovered together, is the maker of both Rawlings baseball gear and K2 skis. (By the way, training kids to ask "who makes this and are they public?" about products they like is another lifelong habit that will serve them well.) For older kids, companies like Nike (NYSE: NKE  ) or Apple (Nasdaq: AAPL  ) may be the ones that grab their attention. No matter which they choose, get in the habit of asking each other questions: How is the company doing? Why? Who is it competing with? Has it made good (or bad) decisions recently, and how have those worked out? Build a mock portfolio and follow it together.
  • Make some investments. Nothing teaches quite as well as having money at risk, so after you've followed that mock portfolio together for a while, have them buy some real shares of stock. As a practical matter, it's best to hold the child's investments in your own brokerage account -- if your children hold assets in their own names, their eligibility for college financial aid can be limited. A few shares of each company is fine, especially for younger kids; the point is to increase their feeling of involvement, not necessarily fund medical school. Follow the news, look at quarterly releases together, and spend some time with the annual report when it arrives in the mail. Ask questions like: What is the company trying to say? Is that different from what you think is really happening? How are they actually doing?

Finally, once you've sparked their interest, feed it. Joel Greenblatt's The Little Book That Beats the Market is a wonderfully accessible (and funny) book many teens will enjoy, and the Fool's Teens & Their Money resource area is a great place to look for financial wisdom -- and it's free. You might not end up with a hedge fund whiz, but with a little effort and luck you'll end up with a kid who knows the difference between a hedge fund whiz and an overpriced, underperforming investment manager -- which, as far as I'm concerned, is just fine.

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