by Ken Townsend
My in-laws want to give my child a gift that will increase in value instead of a toy she will outgrow in a matter of months. Should they invest in stock, savings bonds, or put money in a savings account?
If the child is young and the expectation is that this investment will not be required until college age, I would definitely recommend that the investment be in stocks. Stocks are more volatile over the short term, but over the long term, stocks have appreciated much more than bonds or savings accounts, and I believe they will continue to do so. As the child gets close to the time the money will be needed, for example for college expenses, some of the money should be shifted to bonds to provide a little more stability for the investment portfolio.
I strongly recommend that your inlaws not invest in a single stock or even a handful of stocks. Mutual funds offer the advantage of diversification that will reduce the risk of failure by one or two stocks in such a portfolio. I recommend a low-cost index fund, such as that offered by the Vanguard Group (www.vanguard.com). More specifically, investment in a Total Market Stock Index Fund will provide the needed diversification and growth in line with the overall domestic stock market.
The mutual fund could be held in an account in the child’s name with the in-laws or the parents as custodians. The income and appreciation will be taxed over the years.
A cautionary note on custodial accounts: At the time the child reaches the legal adult age, he or she is free to withdraw and use the funds for any purpose without agreement by the custodian.
Another perhaps more interesting choice is a College Savings Plan, such as the Georgia College Savings Plan (www.gacollegesavings.com). There is a tax advantage for College Savings Plans. While contributions are generally not tax deductible, the funds after appreciating over the years may be withdrawn eventually for qualified college education expenses, free of federal and state taxes. Thus the appreciation over the years will not be taxed if the proceeds are used for qualified college education expenses.
In the Georgia College Savings Plan, one cannot invest in a single mutual fund as suggested earlier. The choices include a combination of managed investments very similar to mutual funds. The investments start out with mostly stocks, but automatically adjust over time to more conservative investments containing less stock as the child gets closer to college age.
A cautionary note on College Savings Plans: Withdrawals for purposes other than qualified college education expenses will result in payment of taxes and a penalty.
Ken Townsend, founder of Townsend Financial, provides personal financial planning and investment management services to residents of the Chattahoochee Valley. Townsend earned degrees from both Georgia Tech and the Wharton Graduate Business School. He is a Certified Financial Planner and a registered, independent investment advisor.
