Whether you’re a new parent or a grandparent, one of the things you’ll undoubtedly think about is how to save for your child’s future. In days past, the concept of saving may have been collecting the five dollar bills from birthdays and holidays that your child or grandchild would stash in a piggy bank, but technology has made it so easy to make those five dollar bills go further.
The best investments for kids don’t require starting the day they’re born, but the sooner, the better!
Compounding at a good rate of return over a long period of time makes it really easy to create millions for your child to retire on. Here is an example of the power of compounding: A child who invests $50 a month from age eight to age 13 (a total investment of only $3,600 over the six-year period) will end up with more money at age 65 ($1,302,154) than someone who starts investing at age 26 and invests $2,000 EVERY YEAR until he or she reaches retirement age. Those results are based on an 11% annual return, or only 1% higher than the long-term (since 1926!) 10% average return of the S&P 500.
Ultimately, we think the best way to invest this money is in a Dividend Reinvestment Plan (DRIP). The plans can be made in your child’s name, and they don’t need to take a sick day off from school for broker calls because their investments are directly with the company. DRIPs are particularly good long-term investments, which makes them perfect for kids.
Why Dividend Reinvestment Plans are the Best Investments for Kids
When we asked DRIPs expert Vita Nelson, she suggests Dividend Reinvestment Plans as one of the best investments for kids. She says that children can grow very rich—very easily—because they have time on their side. It’s as easy as one, two, three:
1. Buy one share of a (hypothetical) DRIP stock = $54.05.
2. Invest $25 per month for 65 years = $19,554.05.
(Total amount invested over the period of 65 years)
3. Total Value at Retirement = $1,974,393.97.
(Assumes average annual return of 10% including dividends)
Note: This is simply to capture your attention by demonstrating the effect of compounding over the long term. We are not suggesting that any one stock will produce an average annual return of 10%. Rather, we suggest that you invest in a basket of companies in diverse industries. Your Total Value at Retirement will depend on the number of companies you are funding and the amount you are investing in each. In our example we invest just $25 per month. You would achieve proportionately higher returns based on committing more money — rotating investments among stocks in a diversified portfolio.
Opening a DRIP for your kid is relatively easy—you can open it for them as long as you know certain information, like their social security number. You could invest as little as $10 in a company like Coca-Cola (KO), for example. Unless you want to pay taxes on the income your child earns, it’s advantageous to put the plan in their name, not yours.
We recently came across a couple of articles from Charles A. Carlson, editor of DRIP Investor, and a contributor to our Wall Street’s Best Digest advisory, which offered a fresh look at dividend reinvesting, and he notes that another reason why DRIPs are one of the best investments for kids is that since you deal directly with the company, the child does not have to go through a broker or endure broker calls.
“Since time is so critical to investment success, the more time you have, the better off you are,” says Carlson. “A 10-year-old who starts setting aside money today will be tomorrow’s millionaire. Look at the numbers: A 10-year-old that invests just $10 a month—perhaps money earned from a paper route or doing chores around the house, or perhaps funds accumulated from birthday or holiday gifts—will see his or her funds grow (assuming an average annual return of 10%) to more than $174,000 by the time he or she reaches age 60. In other words, that total investment of $6,000 over the course of 50 years becomes $174,000. And if he or she can pony up (with a little help from mom and dad) $50 per month, that investment of $30,000 over a 50-year period will turn into more than $873,000.”
Carlson also suggests another route: the buddy system. “Let’s say that you already own shares in Coca-Cola (KO). You can transfer one of your shares from your account to an account set up for your child or grandchild, thus making him or her a registered shareholder and eligible to join the plan. Transferring shares is easy. Just secure a ‘stock power’ form from a broker or the company’s transfer agent. Fill out the stock power form. When you’ve done this, take the form to a bank to receive a ‘medallion’ signature guarantee. Once the form has been stamped with the medallion, return it to the transfer agent. You might want to include a letter stating your intentions and specifying that you would like to enroll the individual directly into the dividend reinvestment plan. Most companies will oblige. The process costs little or no money to complete and is very easy.”
To avoid tax issues, Carlson recommends setting up the DRIP in the child’s name under a Uniform Gifts to Minors Account (UGMA).
“Funds in the account are in the minor’s name and social security number and are considered to be owned by the minor. Dividends paid on the account are taxable, most likely at a preferred tax rate. The adult custodian is responsible for the account until the minor reaches the age of majority. Any withdrawals from the account are payable to the custodian on the minor’s behalf until that time. However, once the youth has reached the age of majority—18 in many states—control of the account reverts to him or her to do with as he or she sees fit. This is the downside of setting up a UGMA. Parental control is lost at the age of majority. Hopefully, by the time a child reaches 18, the principles of investing are so ingrained that he or she would be reluctant to squander funds that took so long to accumulate. Nevertheless, it is important to understand the pluses and minuses of UGMAs before registering the shares in that form.”
Dividend reinvestment plans may seem boring or confusing to a young child or teenager. But if you’re looking for a nice birthday gift for your kids or grandkids, it’s something they’ll likely come to appreciate over time.
What else would you like to know about DRIPs or the best investments for kids? Leave a comment below.