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We
have 4 grand children that we have been purchasing stock for at
Christmas for the last 10 years. The stocks are valued from $500
to $3,000. The brokerage house fees were running too high even though
we had them under our account. We have just liquidated the accounts
and our goal is to look for the best place to invest this money
and continuing our yearly $150 contribution for each.
Rich
Rich
is right. Investment expenses matter. The Securities and Exchange
Commission calculates that a 1% difference in expenses on a $10,000
investment earning 10% annually would mean a difference of $11,133
in 20 years. Rich isn't investing that much, but clearly the difference
is dramatic.
And
Rich is also right that beginning a savings program for children
is a great idea. For instance, a public college that costs $12,841
per year today would cost $36,652 in 18 years if costs rise 6% per
year.
There
are two things for Rich to consider. First, how will he invest.
And, second, how will the investment be legally owned.
Owning
individual stocks is very hard unless you're going to be investing
more than $150 at a time. Even a minimal $8 commission reduces your
$150 investment by more than 5%. So it takes 6 months or so to earn
enough to make up for the commission paid.
Generally,
mutual funds offer more flexibility for the small investor.
The
average expense for a mutual fund that invests in domestic stocks
is 1.4% per year. That's a whole lot better than the cost of buying
individual stocks.
Owning
a mutual fund allows you to reinvest dividends. Something that's
almost impossible with an individual stock unless a DRIP (dividend
reinvestment plan) is available. If a DRIP is available for your
stocks in this situation it would be wise to use it.
Rich
will want to consider something called an 'index' fund. Those are
funds where management does not try to pick stocks that will beat
the market. The fund is managed so that it reflects the make up
of an index. For instance an S&P 500 fund would have shares
in the same proportion that they were in the S&P 500 index.
Shares would be bought and sold to maintain that proportion.
There
are two main attractions to index funds. One is that their expenses
can be lower. For instance, the Vanguard S&P 500 fund has an
expense ratio of about 0.18%. But check the expenses on any fund.
Some index funds have ratios as high as 1.5%.
The
index funds also generally perform better than the average managed
mutual fund. As it turns out, most managers don't earn more than
they charge the fund. And that means that the average fund does
not perform as well as the market.
If
you are going to consider a managed fund, look for one that has
a good 10 year track record. A great one or five year track record
could have been caused by some unique factors that had nothing to
do with the fund's managers. And, that could actually work against
the fund once you've bought it.
How
should the investment be owned? Ideally, Rich would set up a UGMA
(uniform gifts to minors account) for each child. He (or any legal
adult) could act as custodian until the child became an adult.
Because
legally the child owns the money, Rich would not be liable for any
taxes on dividends or capital gains. The one disadvantage is that
the child can use the money however they choose when they reach
the age of adulthood.
Using
a UGMA account has another advantage. As they become old enough
to understand, you can review the quarterly statements with them.
It's a perfect opportunity to teach them the basic facts about money.
There's
another, non-financial benefit of talking to your kids about their
investment account. Often children strive to achieve our expectations
for them. Knowing that you're saving for their college could encourage
them to strive for the grades that they'll need.
Rich might also encourage his grandchildren to add to the fund themselves.
Kids often receive cash gifts. If they take just a small portion
of each gift and add it to their investment account they'll take
a keener interest in the account. And, they'll learn how to be investors.
Finally,
one of the most valuable gifts that you can give a child is an understanding
of how compound interest works. There's a huge gulf between people
who are paying interest on credit cards and those who are collecting
interest on investment accounts. Getting on the right side of that
gulf is important.
_________
Gary
Foreman is a former financial planner who currently edits The Dollar
Stretcher website <www.TheDollarStretcher.com>.
The site have hundreds of ways to help you stretch your day and
your dollar. Visit today!
Gary Foreman is a
former Certified Financial Planner who currently edits The Dollar
Stretcher website at www.stretcher.com.
You'll find hundreds of free articles to stretch your day and your
budget.
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