As parents, we want to be able to provide for our kids. Part of providing is to make smart financial decisions that can help them in the future.
One way to do this is to take their money out of a savings account that’s earning a measly 1% of interest and instead investing it into a well-diversified index fund or ETF.
If you’re investing on behalf of your child, the appropriate account is called a Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) types of custodial accounts set up by parents to hold assets of minors. These can easily be set up with most online brokers.
But aren’t we taking on some risk when we invest our children’s money? Is it really a good idea? Well, let’s see.
Long-Term Return – Savings Account Versus Index Fund
Let’s say you start contributing to your child’s saving’s account at the age of five. You accumulate all that birthday money and other times family and friends gifted money to your little one. Let’s assume it comes out to $5,000.
What does $5,000 in a bank account earning 1% a year VS earning an average of 11% per year in the stock market look like? Take a look for yourself:
|Age||Amount||1% Per Year||Amount||11% Per Year|
|5||$ 5,000.00||$ 50.00||$ 5,000.00||$ 550.00|
|6||$ 5,050.00||$ 50.50||$ 5,550.00||$ 610.50|
|7||$ 5,100.50||$ 51.01||$ 6,160.50||$ 677.66|
|8||$ 5,151.51||$ 51.52||$ 6,838.16||$ 752.20|
|9||$ 5,203.02||$ 52.03||$ 7,590.35||$ 834.94|
|10||$ 5,255.05||$ 52.55||$ 8,425.29||$ 926.78|
|11||$ 5,307.60||$ 53.08||$ 9,352.07||$ 1,028.73|
|12||$ 5,360.68||$ 53.61||$ 10,380.80||$ 1,141.89|
|13||$ 5,414.28||$ 54.14||$ 11,522.69||$ 1,267.50|
|14||$ 5,468.43||$ 54.68||$ 12,790.18||$ 1,406.92|
|15||$ 5,523.11||$ 55.23||$ 14,197.10||$ 1,561.68|
|16||$ 5,578.34||$ 55.78||$ 15,758.79||$ 1,733.47|
|17||$ 5,634.13||$ 56.34||$ 17,492.25||$ 1,924.15|
|18||$ 5,690.47||$ 56.90||$ 19,416.40||$ 2,135.80|
|19||$ 5,747.37||$ 57.47||$ 21,552.20||$ 2,370.74|
|20||$ 5,804.84||$ 58.05||$ 23,922.95||$ 2,631.52|
|21||$ 5,862.89||$ 58.63||$ 26,554.47||$ 2,920.99|
Simple Summary: now at their 21st birthday, they can either cash out two ways, one they have earned less than a $1,000 in interest for 16 years or not even one-fifth of the initial investment.
Or they can cash out with over $26,000 or over 5 times the initial investment; a simple decision, right?
You can add money into their account whenever they accumulate a few hundred bucks.
Even with the trading costs, your kids are better off with their funds invested rather than saved.
Your Kids Will Be Excited To Learn About Compound Interest
Recently my son asked if we could take out all the money he has from the bank so he can put it in his pocket.
I gave his question some thought simply because I thought it was rude to outright say no.
I didn’t go into the details of compound interest. Instead, I just explained that his money can work with other money to make more money for him. They work together in a magical way. And years later, the money can double, triple or grow even larger. He just gave me a big smile and said: “ok, just leave it there then.”
And actually, explaining this concept to him allowed me to take the leap and withdraw his funds from the measly 1% money market account and open up a custodial investment account. Ofcourse he still has a bit in the savings account for big expenses (e.g., he wants a Play Station 4 for his birthday next year, but we shall see).
Tax-Advantage For Kids
It seems like whenever we are doing something smart and sensible with our personal finances, taxes propel us and entice us to move forward.
For example, generally over $1,000 in investment income from these minor custodial accounts is tax-free.
Even in their teen years and throughout college, there is a serious lack of financial education in the schooling system. It’s the primary responsibility of parents to teach their kids and help them make strong financial decisions that will yield favorable future results.
The biggest advantage our kids have is time. The second biggest advantage they have is to leverage from informed parents like many of us to guide them to make wise financial decisions to help secure their future.
I’d like to point out that I am not a professional investment advisor. I strongly advise you to consult with an investment professional before making investment decisions for yourself or your family.
Join The Discussion:
- Do you have a UGMA/UTMA account for your child?
- What’s the best way to teach kids about money?
- Do you remember an important money lesson as a kid?
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