You may have heard that investing is the best way to build wealth for the future. Well, that advice doesn’t apply to just you. It also applies to the children in your life.
Saving money for your child or another child in your life can give them a huge step up in the future. And thanks to compound interest, investing can help that money grow exponentially, helping the child pay for college, get a headstart on retirement savings, and reach just about any other financial goal.
But as you might suspect, investing for a child looks a bit different from investing for yourself.
To help you start investing for the children in your life, we’re sharing the best children’s investments, what to consider when choosing investments for a child, and the best types of accounts to start investing in.
We all want the kids we love to grow up without being weighed down by heavy financial burdens. Unfortunately, most families just aren’t investing for the future.
Less than half of US adults say they don’t have a rainy day fund, while around one in five admit to spending more than they’re earning. This means less money to pass on to future generations. So, if you’re serious about creating a nest egg for your kids, it’s important to get started as soon as you can.
When parents sit down to decide how they want to build wealth for the next generation in their family, they’re normally faced with two options: to either save or invest.
Generally speaking, saving has more of a short-term focus. You save to create a rainy day fund that you’ll be able to dip into relatively easily.
Savers normally deposit cash into a money market account or a certificate of deposit (CD) account. With savings accounts, there’s almost no risk that you’re going to lose your savings — but you’re not going to see big gains, either.
That’s why many parents choose to set up an investment account for their child alongside a savings account.
Investing is a long-term strategy. Instead of focusing on building an emergency fund you might need in the next year or two, investing enables you to create wealth that you and your loved ones will be able to use in the decades to come.
When you invest, there’s always the chance that the assets you’ve invested in will decrease in value. But generally speaking, investing is likely to make your money work harder thanks to compound interest.
According to Goldman Sachs, the average ten-year stock market return has increased by 9.2% per year for the last 140 years — and those aren’t even the best possible returns. The S&P 500 index has brought in average returns of 11.6% per year over the last decade.
It’s also important to note the risk of your savings being outstripped by inflation. When you place cash into a savings account, currency inflation could end up outpacing the compound interest that account is able to build. This means your money in a savings account might lose value over time.
But if you invest in an asset whose value increases, it shouldn’t make a difference whether a currency is worth more or less. Either way, your investment will have increased in value over time.
Before you invest a penny for the future, you should sit down and consider where you and your family stand on some of the key fundamentals of investment.
These include your risk tolerance, time horizon, investment goals, and diversification.
Your risk tolerance describes how much you’re willing to risk losing in order to make gains.
Investing isn’t a sure thing, as there’s always a chance the assets you’re investing in could decrease in value.
Before you invest, you have to decide how much you’re comfortable risking in pursuit of high returns — and a big part of your risk tolerance tends to link pretty closely to your time horizon.
Your time horizon is the amount of time you’re expecting it to take to reach a specific financial goal.
Generally speaking, you’re working with a longer time horizon when investing for children — and because of this, you can afford to take on a little more risk. This is essentially because, if your assets do end up dropping in value, you can rejig your portfolio and still have plenty of time to meet your long-term financial targets.
Your investment goal is the reason you’re putting money away. It might be to save for your child’s wedding, down payment on a future house, college tuition, or even future retirement.
Whatever your goal, it helps to attach a monetary value so that you know roughly where you need to be within your allotted investment time horizon. This will dictate how much risk you’re willing to take on, the vehicles you use to invest, and how much you put toward achieving your goal.
Diversification is the process of creating a broad mix of assets within your portfolio. By investing in a few different assets, you won’t have to worry about putting all your eggs in one basket.
For example, let’s say you put all your money in stocks, and then the stock market crashes, threatening the value of your portfolio. If you’ve also invested in government bonds and cryptocurrencies, the value of your portfolio won’t be 100% linked to stock performance. This should cushion the blow so that you’re able to recover quicker.
OK. So, we’ve already mentioned that having a diverse portfolio is important when considering different children’s investments. Now let’s take a look at some of the best assets you can invest in for children.
When people talk about investing, stock shares are normally the first type of asset that comes to mind.
Stock shares represent a portion of ownership in a publicly-traded company. When you invest in a company’s stock shares, you become one of its many owners — also investing in the hope that the company will do well financially and grow over time.
Because there’s no guarantee that a company will succeed, stocks carry a certain amount of risk.
Stock shares can also sometimes generate unearned income through dividends. Dividends are a nominal payment companies often distribute proportionally to shareholders when times are good and the business is making a profit. You can invest in stocks using a fairly wide range of investment vehicles, or you can invest directly in the market using a brokerage account.
When you purchase a bond, you’re loaning money to a company or the government. The entity you’ve purchased the bond from will then repay you over a number of years.
The company or government you’ve loaned money to will also pay you a nominal interest fee. This is what helps you to generate a profit by purchasing a bond.
A mutual fund is an investment vehicle that consists of a portfolio or “basket” of stocks, bonds, and other securities.
The benefit of investing in mutual funds is that they’re operated and maintained by professional financial managers. Those managers use the pool of money provided by investors to purchase shared assets — with the goal of producing capital gains or income for mutual fund shareholders.
Unlike other asset classes, such as exchange-traded funds (ETFs), mutual funds own all the securities in their baskets.
An exchange-traded fund (ETF) is an index fund that tracks a basket of securities. Unlike mutual funds, ETFs don’t require you to get involved in buying actual securities. Instead, the value of an ETF simply goes up or down based on the performance of the securities the index is tracking.
Because ETF shares are treated like in-kind distributions (which means you can’t redeem them for cash), they’re considered one of the most tax-efficient ways to invest in the market.
Real estate is a very different kind of investment — and a lot of money managers will recommend that you consider investing in real estate to diversify your portfolio. By purchasing real estate, you’re essentially placing a bet that property prices will rise and your asset will appreciate in value.
That being said, you can also generate income through real estate by renting out a property or fixing up undervalued real estate and flipping it for profit.
A cryptocurrency (or “crypto”) is a digital currency based across a global network of computers. Because cryptos are decentralized, they exist outside of the control of central banks and governments.
As a result, regulators treat cryptos like a commodity rather than a currency — although some payment service providers and retailers will allow you to use crypto to pay for goods and services.
While you’ve probably heard of big cryptos, like Bitcoin and Ethereum, thousands of others are available to trade through digital crypto exchanges. When you invest in crypto, you buy it using a digital wallet. You can then either continue holding it in that wallet or download it onto an offline or “cold” wallet.
A Uniform Gifts to Minors Act (UGMA) custodial account is an investment vehicle an adult can use to store assets for a minor beneficiary.
When you set up a UGMA account, you must manage the assets in that account as its “custodian” until the beneficiary reaches the age of majority in their state — usually either 18 or 21.
Because everything in a UGMA account is the legal property of the minor beneficiary, custodial accounts normally generate tax savings for families, as any unearned income the account generates up to a certain threshold is taxed at the child’s (normally) lower tax rate.
UGMA accounts also don’t have contribution limits. This means that, thanks to the IRS Gift Tax, you can gift up to $16,000 per year into a child’s account without needing to pay taxes on it.
If you set up a UGMA using EarlyBird, you get to choose from one of five ETF portfolios based on your risk tolerance, time horizon, and investment goals.
A 529 is a state-run college savings plan that lets you invest cash in pre-selected mutual funds or ETFs. The type of securities basket you’re able to invest in will depend on the state you live in.
A major benefit of 529 plans is that all of the money you invest in a plan grows tax-free. As long as you’re making withdrawals for “qualified education expenses,” you won’t get taxed. However, the state definitions of qualified expenses are usually pretty rigid, so you can often only use a 529 plan to pay for tuition, admin fees, and (sometimes) on-campus accommodation.
If you take money out for anything that’s not on the list, you’ll have to pay both a penalty and a tax on that withdrawal. 529 contribution limits are also normally quite low — which is why many families decide to set up a custodial account alongside a 529 plan.
A custodial individual retirement account (IRA) is an investment vehicle a parent or guardian can create for a minor who has their own income.
The cash you place into a custodial IRA is then able to grow tax-free over time. This means you won’t have to pay the IRS for any capital gains, and you won’t get charged to make withdrawals if the beneficiary is of retirement age. A custodial IRA is, therefore, a very long-term investment to make for a child.
It’s also worth noting that IRAs usually have low contribution limits, and you can’t gift money into the account. Custodial IRA deposits must be sourced from the child’s own income.
That makes them ideal if your kids earn regular cash babysitting or mowing lawns. But if you’re trying to set up an investment for a baby or toddler, a custodial IRA isn’t the right move.
Choosing investments for your child’s future can feel overwhelming. You want to set them up for success by making investments that will grow enough to help them reach their future goals while presenting minimal risk. After all, you want to make sure the funds will be there when your child needs them.
The good news is that the same investments that can help you prepare for your own future can also be a great addition to your child’s investment account. No matter which type of investment account you choose to open, a diversified portfolio built with children’s investments like stocks, bonds, and funds is sure to help the children you love reach their future goals.
Download EarlyBird today to open an investment account and start investing for your child.