Diversification For Children

After reading a comment by Single Ma not long ago, I realized that it would be a great idea to distill some of the more basic ideas about investing down to a simple level so that even a small child could understand them and not become bored at the idea of investing in the stock market.

The first and most important concept that people like to talk about when it comes to investing is diversification. By putting all of your money in one place, you make it easier for it to all get lost at once. There are two simple ideas to run by your little one when getting this idea across.

What if you had two one-dollar-bills. That’s two dollars, right? What if you wanted to make sure that the money that you had was safe because you had something that you wanted to buy with it in a few weeks - a new candy bar or bike (if it was 200 dollars)? What would be a good way to do that? Here is where you let your little one speak up and come up with ideas. This thought process is almost as important as getting the right answer because developing problem-solving skills and being imaginative is likely just as important as getting the point about diversifying.

No matter what the child responds with as the answer, say that it is robbed, or is stolen, or is burned up. This could be a bank, a bully, or a robber. The point is that it doesn’t matter. However, once your child realizes that by splitting the two dollars into two separate amounts of a dollar each, or even further into smaller amounts, then you show that your child likely still has the money.

This simple story shows the basic idea of diversification, that putting the money in many different places is best. The second concept of diversification is more subtle. That is, making sure the investments are different enough from each other.

For this, go back to the original example. If the money is put into two different banks, show that a bank robber robs all the banks. Or if it is kept between a couple of people, say a mugger comes and takes all the money of all the people the child gave the money to.

Obviously, your child needs to understand that this is a “what-if” type of game you are playing. And the chances of losing the money are lower if the money is put into one bank and one home. Or some is kept with you, some is kept with someone else, and some is kept at a home or a bank. By showing the child that the chances are more likely that all of the money would be lost more easily if it was all protected the same way, the concept is made clear.

If you have ideas about how to teach diversification to children, please comment here. I’m always interested in these ideas as they relate to children since I plan on teaching my brother about this stuff as he grows up!