For Parents

Teaching Kids About the Importance of Diversification in Investing

Big words don’t have to be difficult to teach. Here are the basics of this really important concept!

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You see it in the news every day: a company like Blockbuster, once a household name, files for bankruptcy because it failed to adapt to changing market conditions. If you’d invested all your money in Blockbuster, you’d have lost everything. But what if you spread your investments across various assets? You’d have minimized your risk and potentially reaped greater rewards. Now, imagine teaching this concept to your kids, empowering them to make informed financial decisions. How do you explain diversification in a way that’s relatable to their everyday lives?

What Is Diversification In Investing?

How do you explain a complex financial concept like diversification to a young kid? You can start with a simple analogy they can relate to, like their favorite ice cream shop.

Imagine the ice cream shop only sells one flavor, vanilla. If a lot of kids in the neighborhood suddenly decide they don’t like vanilla anymore, the shop will sell less ice cream and might even go out of business.

Now, imagine the same ice cream shop selling many different flavors—vanilla, chocolate, strawberry, and more. If some kids don’t like vanilla, that’s okay, because they’ll have other flavors to choose from. The shop will still sell ice cream and stay in business.

This is basically what diversification means in investing. It’s a way to distribute your money across many different types of investments, so if one type isn’t doing well, the others can help make up for it.

You can use this analogy to explain to your kids that when we invest our money, we want to put it into different things, like stocks, bonds, or real estate, so we’re not relying on just one thing to do well.

How to Explain the Benefits of a Diversified Portfolio to Your Kids

As you further explore the concept of diversification with your kids, explaining the benefits of having a diversified portfolio is essential. Start by asking your kids to imagine they’ve all their money invested in one stock or asset and then think about what would happen if that stock lost value. This is a great way to help them understand the concept of risk and how spreading their investments across different assets can help mitigate it.

You can then explain that a diversified portfolio is like having multiple baskets to hold their eggs. If one basket (or investment) were to fall and break, the other baskets would help protect their overall portfolio. By spreading their investments across different asset classes, such as stocks, bonds, and real estate, they can help guarantee that a loss in one area doesn’t devastate their entire portfolio.

Another key benefit of diversification is the potential for greater long-term returns. Investing in different industries, sectors, and countries allows investors to access growth opportunities that may not be available in a single stock or asset.

When explaining this to your kids, be sure to emphasize the importance of patience and a long-term approach, as diversification is a strategy that takes time to bear fruit.

Teaching Diversification With Real-Life Examples

Beyond the theoretical explanations of diversification, bringing the concept to life with relatable examples can make a significant difference in your kids’ comprehension. You can use everyday situations to illustrate the benefits of diversification. For example, explain to your kids that having a variety of favorite foods in the pantry guarantees they’ll always have something they like, even if one food is in short supply.

Similarly, having a mix of different investments can protect their portfolio from fluctuations in the market.

You can also use examples from their own experiences, such as a lemonade stand or a small business venture. Ask them to imagine they’re running a lemonade stand and they only sell one flavor. If that flavor goes out of style, their business will suffer.

But if they offer multiple flavors, they can attract a wider range of customers and reduce their risk. This simple example can help your kids understand the value of diversification in a tangible way.

Another relatable example is a garden. If you only plant one type of flower that is susceptible to disease or pests, your entire garden could be wiped out.

But if you plant a variety of flowers, you’ll have a better chance of having a healthy and thriving garden. By using these real-life examples, you can help your kids grasp the concept of diversification and its importance in investing.

This will lay the foundation for more advanced lessons on diversification and investing.

Creating a Diversified Investment Portfolio

You’ve helped your kids understand diversification through relatable examples. Now, it’s time to apply this concept to real-life investing.

Creating a diversified investment portfolio is essential for minimizing risks and maximizing returns. You can explain to your kids that a diversified portfolio is like a team of superheroes, each with unique powers that work together to achieve a common goal.

Imagine you’re investing $1,000 in the stock market. Instead of putting all your money into one stock, you spread it across different asset classes, such as:

  • Stocks (e.g., Apple, Amazon, or Google)
  • Bonds (e.g., government or corporate bonds)
  • Real estate (e.g., a real estate investment trust or REIT)

This way, if one investment performs poorly, the others can help balance it out.

You can use a simple example to illustrate this concept:

  • Stock A goes down by 10%, but Stock B goes up by 10%, and Bond C stays steady. Your overall portfolio might only decrease by 2-3% instead of 10%.

Making Diversification a Family Affair

With a solid understanding of diversification and its significance in investing, it’s time to involve the whole family. You’ve learned how to create a diversified investment portfolio, and now, sharing this knowledge with your kids is crucial. By making diversification a family affair, you’ll teach your kids valuable financial skills and strengthen your family’s financial future.

You can start by explaining the concept of diversification in simple terms that your kids can understand. Use real-life examples, such as a garden with different types of flowers or a stock portfolio with various companies. This will help them grasp the idea of spreading risk and increasing potential returns.

Encourage your kids to ask questions and participate in discussions about investing and diversification.

Give your kids a hypothetical amount of money to invest and involve them in creating a diversified portfolio. Let them choose different assets, such as stocks, bonds, or mutual funds, and explain the reasoning behind their choices.

This hands-on approach will help them understand the importance of diversification and make informed investment decisions. By working together, you’ll create a sense of teamwork and shared responsibility for your family’s financial well-being.

As your kids grow and become more confident in their investment knowledge, they’ll be better equipped to make smart financial decisions and achieve their long-term goals.

Diversification Is Key To Long-Term Investing Success

As you nurture your child’s financial garden, remember that diversification is the sunshine that helps their investments grow strong and resilient. By teaching them to plant a variety of seeds – stocks, bonds, and more – you’re showing them how to weather any financial storm. As they attend to their portfolio, they’ll learn to prune risk and harvest returns, cultivating a bright financial future that will bloom for years to come.

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About the Author

David McCurrach

David McCurrach is the founder of Kids' Money. Following a career working in finance for several banks and credit unions, David started Kids' Money in 1995 and has since published three books on kids' financial literacy and allowance programs.

Last updated on: January 21, 2025