Baby Bonds: Seeking To Create An Equal Future For All Kids

November 4, 2021
investment strategy

Have you heard the news about baby bonds?

The term has been used to describe proposed funds created for every newborn in America upon their birth. 

The goal of these trust funds is to try and give every child in America a more equal opportunity.

But the term baby bond is also used to refer to a type of fixed-income security. 

These are small-denomination bonds that can be bought and sold on the stock market. They have nothing to do with the new form of baby bonds that politicians are currently proposing.

This article will explain both ways that the term can be used and provide clarification between them.

What Are Baby Bonds? (As a Government Policy)

Baby bonds are a government policy that would see every child receive a publicly-funded trust account at birth.

The government might choose to introduce baby bonds for different purposes. 

Baby bonds can be issued to fund an account for post-secondary education. Or they may be set up using more general accounts that help kids understand finance and show them the benefits of saving.

A few countries have already tried to implement baby bonds as a policy.

In the UK, baby bonds took the form of a “child trust fund,” through which eligible kids could receive at least £250 from the government. This program has since been discontinued.

Hungary currently has a program where babies born after 2005 receive a tax-free savings bond worth around $200. Children in need are eligible for two extra payments when they reach ages 7 and 14. The money is kept in trust until the child turns 18. Parents can also make tax-free deposits to the account.

Baby bonds have been proposed several times in the US but haven’t been made into law so far. The main reason the idea has come up in the US is to reduce wealth inequality. 

Under most plans, children from low-income families or historically marginalized groups affected by a racial wealth gap would receive a higher level of funding. 

One study from Columbia University suggests that baby bonds, which are means-tested based on family wealth, would reduce the mean racial wealth gap from a factor of 16 to 1.4. This means there would be less financial inequality between white and non-white Americans. 

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History of baby bonds in America

To date, baby bonds have never garnered enough popularity to be more than a proposal. That may soon be changing, though.

During the 2008 Democratic presidential primaries, Hillary Clinton proposed a one-time $5,000 baby bond plan. However, it was later removed from her platform.

In 2010, economists William Darity Jr. and Darrick Hamilton proposed baby bonds that would work on a sliding scale based on the net family income of each newborn. 

Children in the lowest quartile would receive a starting value as high as $60,000. The trusts would be federally managed and provide a return of 1.5% to 2% per year, which a child could access after they turned 18. Darity and Hamilton estimated that the baby bond program would cost $60 billion per year to implement.

In 2018, Senator Booker introduced a bill called the American Opportunity Accounts Act. It called for the creation of an American Opportunity Account (AO) for each newborn child. 

The proposal would see each account receive an initial investment of $1,000, with an amount added each year based on a child’s household income level. 

Children below the poverty line would receive an additional $2,000 per year, resulting in an estimated account balance of around $46,000 by age 18.

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Most recently, in 2020, New Jersey Governor Phil Murphy proposed a scaled-down version of Corey Booker’s 2018 proposal. It sought to provide a one-time $1,000 baby bond for newborn children of families whose parents make 500% or less of the federal poverty level.

To date, none of these proposals have passed.

How do baby bonds work?

Unlike regular bonds, baby bonds in this context aren’t something that can be bought and sold on public markets like a regular bond.

In actuality, baby bonds are trust accounts. Some may wholly or partially contain bonds (fixed-income securities). Some of the proposed baby bond plans could contain an assortment of federally-managed investments, including bonds, equities, and other assets.

The main concept behind baby bonds is that every child would receive a publicly-funded trust account at birth. The main feature of most baby bonds is additional funding for low-income families or marginalized groups. 

One of the primary reasons baby bonds are being proposed is to decrease the wealth gap and give all children a more equal starting position in life.

Pros and cons of baby bonds

Baby bonds are still a contentious issue for most American voters and their representatives. Here are some of the pros and cons that will need to be considered before baby bonds become a reality.

Pros:

Every child would get one. Baby bonds would help more Americans in the long run. 

The US currently has a Child Tax Credit that provides up to $300 per month. However, you can only receive the Child Tax Credit if you’ve filed tax returns for 2019 or 2020. 100% of children born after baby bonds are introduced would receive the benefit. Under some proposals, any children under age 18 at the time the legislation was passed would receive some benefits.

It promotes equality. Baby bonds are an attempt to give every American child a more equal start to life, reduce generational poverty, and close the racial wealth gap. 

No child should be deprived of the economic opportunity to attend higher education or start a business simply because of their family situation while growing up.

Cons:

Impact on taxpayers. The types of baby bonds proposed so far would have an estimated cost to the American taxpayer of $60 billion per year.

No immediate assistance. Children wouldn’t be able to use the funds until they turn 18. Some families would prefer tax credits that offer immediate assistance to families. They can use the money from tax credits to buy things that their children need right now.

Lack of guidance for the funds. Handing a savings account to a child on their 18th birthday without proper education about finances may lead to a less-than-desirable outcome. 

The American Opportunity Accounts Act and other baby bond proposals would restrict funds to “wealth-building activities” like buying a home, starting a business, or going to college. Still, an 18-year-old may not have the knowledge necessary to make the best financial decisions.

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What Are Baby Bonds? (As A Fixed-Income Security) 

Historically, the term “baby bonds” has been used to refer to low-value, fixed-income security.

In this context, baby bonds have nothing to do with the government or social programs. They don’t necessarily even need to have anything to do with children.

A baby bond is essentially any bond that has a face value of less than $1,000. They usually have a maturity of fewer than 15 years.

Municipalities, counties, or states typically issue these small-denomination bonds to fund infrastructure and other expensive projects. Some companies also issue corporate bonds that meet the criteria to be called baby bonds.

Baby bonds allow everyday investors to put money into bonds, even if they don’t have large amounts to invest. Traditional bonds may have face values of $5,000, $10,000, or even higher.

Since baby bonds are available in small denominations, they’re also commonly bought by parents, grandparents, and other relatives for the children in their lives.

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How do I buy baby bonds? 

New issue baby bonds are available through the primary market. Think of it like buying a company’s stock through an IPO (initial public offering.)

The easiest way to buy new issue baby bonds is to get government bonds through Treasury Direct.

It’s hard for everyday investors to buy new-issue corporate bonds. And buying new issue municipal bonds usually requires having a brokerage account with the financial institution backing the bond issue.

Buying existing bonds on the secondary market is much easier than buying new bonds and can be easily done through most online brokerage accounts. 

Many baby bonds now trade on the New York Stock exchange and even have ticker symbols, so you can buy them just like stocks.

Are baby bonds safe?

The grade (or quality) of baby bonds can vary depending on where they’re coming from.

Bonds coming directly from the US Treasury are some of the safest investments that you’ll find.

Bonds issued by states or municipalities are usually rated A or better in the bond market, making them low-risk investments. The chances of a city going bankrupt or defaulting on its debts are small.

Corporate-issued baby bonds are where things get trickier. Some may be issued by reputable companies and have a good rating. Other corporate bonds may have a low grade, often referred to as non-investment grade bonds, speculative bonds, or junk bonds.

If you want your baby bonds to be a safe and stable investment, it’s best to look for ones offered by the government at a federal, state, or municipal level.

Do baby bonds expire?

Baby bonds don’t expire, but they will reach maturity just like any other type of bond.

When your bond reaches maturity, you’ll stop receiving regular interest payments and be repaid the bond’s face value.

Most baby bonds have a maturity between 8 and 15 years. However, you can find bonds with a maturity of anywhere from 1 to 50 years.

If you’re buying bonds on the secondary market, be aware that the maturity date on the bond is based on when it was first issued, not necessarily when you purchased it.

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Alternatives to baby bonds

Here are two alternatives to baby bonds that you may want to consider: 

Bond mutual funds

Investing in a bond mutual fund is a good alternative to buying individual bonds yourself.  You won’t need to worry about keeping track of when your bonds reach maturity or buy new bonds to replace them.

Since a bond mutual fund will hold hundreds of bonds, your risk is more diversified than if you were just holding one or two larger bonds of your own.

Bond mutual funds make it easy to reinvest your dividends back into the fund to keep building your investments. Plus, you can buy and sell shares of bond mutual funds almost as easily as buying stock. They offer much more liquidity than holding actual bonds.

Exchange Traded Funds (ETFs)

An ETF is a security that tracks a whole sector, index, or commodity. You can buy and sell them on a stock exchange just like a regular stock.

One benefit of ETFs over mutual funds (including bond mutual funds) is that the management fees are quite low. Many ETFs will have fees from 0.1% to 0.75%. In comparison, mutual funds can often have management fees of 2% or higher.

EarlyBird is a Registered Investment Advisor (RIA) that offers expertly crafted EFT-based portfolios. Our offerings allow you to choose from five fixed portfolios ranging from conservative (100% bond-based ETFs) to aggressive (100% equity-based ETFs).

Your portfolio is balanced based on the age of the child, your investment goals, risk tolerance, time horizon, and other factors.

You can gift as little as a few dollars at a time to a child in your life or make a significant one-time investment — whatever works best for your family. 

Start Saving For The Children You Love

Baby bonds can mean two different things.

It can refer to a government plan that would create savings accounts for all children in the country and provide additional assistance to low-income households.

Alternatively, baby bonds can refer to any fixed-income security with a low face value. Their low value makes it easier for the average person to buy bonds.

But there’s another way to save for the children in your life. 

EarlyBird allows parents, family, and friends to invest in a child’s financial future collectively. You can use the app to save for a child with 100% bonds, 100% equities, or several mixes in between.

Download the EarlyBird app today, and start investing in a child’s future.

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