Investing Tips to Get Kids Started With Mutual Funds

What Are the Best Investment Account Types for Kids?

Some types of investment accounts are created specifically with children in mind, whether to fund college, pass on a legacy gift, or secure the child’s future.

Assuming the child is under the age of 18, they'll generally need a minor account to get started investing. In some cases, minors can open an their own retirement accounts. An adult, such as a parent, can also open investment accounts on behalf of their minor children. Typically, these accounts are to save for school or other long-term goals.

By law, minor children cannot open savings (or checking) accounts. By acting as a custodian, you can set up an account that is the child's property yet remains under your management until they turn 18. Another option would be to set up a joint account that you will both share.

Here are the main types of accounts minors can use for investing:

  • UGMA/UTMA: Accounts created under the Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA) can be used for investing in securities, such as stocks, bonds, or mutual funds, on behalf of a minor. Whether you open an UGMA or an UTMA depends on which state you live in.
  • Roth IRA: Children may qualify to open an Individual Retirement Account (IRA) if they have earned income. For example, if they do yard work for the neighbors or have a small summer job and claim this income on a tax return, they could start their own IRA and begin saving for retirement.
  • Education Savings Account (ESA): Also called a “Coverdell Education Savings Account,” this account is a trust used to save for college. It can also be used for many types of expenses associated with college, such as books, supplies, and sometimes even room and board. Withdrawals are tax-free, so long as the funds are used for these qualified expenses. An ESA account is opened by an adult, who serves as custodian on behalf of the child. The trustee can contribute up to $2,000 each year and no more.
  • Section 529 Plan: Also known as a “qualified tuition plan” (QTPs), the 529 plan is similar to the ESA in that it is designed to pre-pay for a child’s future education. Unlike the ESA, the 529 plan is not a trust that passes to the child, but rather remains in the name of the adult who opened it. 529 plans are sponsored by states and authorized by Section 529 of the federal tax code. These plans offer tax perks and investing options that vary by state.

Accounts designed for children typically come with strict rules from the state so that adults can't take advantage. Steep tax penalties are one way to enforce contribution limits and account spending.

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Start saving for your child’s college early

Ideally, the best time to start a college fund is when your child is born. With compound interest and regular investments made monthly or yearly, the funds have an opportunity to grow over a longer period of time, and you don’t need to put aside as much each month or year to reach your savings goal.

Your funding can be modest, and many parents find they can afford $25–$100 from each paycheck, automatically deposited into the college savings plan of their choice. If you get a raise or bonus, that money (or a portion) can also be allocated toward college savings.

Family members can contribute to a child’s college savings by opening their own 529 plan accounts. They can also make contributions to an established 529 account under the child’s parents’ name, if the plan that the parents use accepts third-party contributions.

Some plans don’t accept these contributions, in which case it’s best to create a new account or gift the parents cash intended for deposit into the 529 plan. Regardless of how the plan is set up, it’s important to maintain contribution levels that will ensure you can afford tuition and other costs. Such discipline can be particularly useful if you face additional financial obligations later.

No matter what plan you choose, starting a college savings fund for your child is a big investment. Let a Nationwide financial professional help guide the process.

How do you set up a custodial account for a child?

Opening a custodial account for a child is similar to any other account-opening process. All you really need is basic information about yourself and the child. If the custodial account is an investment account for mutual funds, then you'll also need to link one of your existing bank accounts to add investing funds.

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5. Fidelity MSCI Information Technology Index ETF

If you’re bullish on tech, you can express that view through the Fidelity MSCI Information Technology Index ETF (FTEC 0.06%). The benefit of investment here is that, for an extremely low annual fee, the fund provides a basket of tech companies weighted toward top-tier names like Apple and Microsoft. While this fund probably shouldn’t be a core holding, it would be a safe bet to allocate 5% to 10% of your college savings portfolio to it for a decade or two. The fund is also a prudent choice for those who are interested in tech but don’t want their funds to become ensnared in the hype of day trading or the lure of headline-grabbing stocks. 

Who Should Invest in a Children’s Fund?

Mutual fund for a child is an ideal financial instrument to create a substantial saving for one’s children. It’s tax-exempted nature, and assured return ensures accumulation of wealth, whereas heavy penalty against early withdrawals deters investors from liquidating the asset before its maturity.

It also offers customisable options for seasoned investors and helps build discipline amongst new long-term investors. Moreover, after the child attains the age of 18, the authorisation is handed over to him or her, providing better flexibility with the invested amount. He or she will only have to complete their KYC from the financial institution to hand over the authority.

This investment avenue is tailor-made for parents who want to create a substantial financial backup for their children to help them build their careers.

Advantages of Investing for Kids

Teach Your Kids Investment Basics

According to a recent Gallup poll, only 56% of Americans own stocks. Many people don’t invest because they find the stock market to be too confusing and don’t know how to get started.

Opening an investment account provides you with a great way to educate your child about how the stock market works and how investing can benefit them. This is a powerful way to provide your kids with the foundation they need to build long-term wealth.

Give Money Time to Grow

The earlier you start, the more your child will benefit from compound growth. Even small contributions can add up over time.

Consider the examples of compound growth below. If you opened an investment account when your child was just 1, here’s how much you’d have if you made monthly contributions to an investment account:

Monthly Contribution Balance When Your Child Turns 18 Balance When Your Child Turns 25
$5 $2,158 $4,333
$10 $4,318 $8,666
$25 $10,795 $21,666
$50 $21,589 $43,332
$100 $43,179 $86,664
$250 $107,949 $216,661
These examples are hypothetical and assume an 8% annual return

Reduce the Need for Student Loans

College is only getting more expensive. According to Vanguard, the price of a public in-state university may increase from $22,690 today to over $52,000 in 2039—the year a 1-year-old in 2022 will likely enroll for their first year of college.

Investing money now for your child’s future will help pay for their education, reducing the need for student loans later on and establishing a solid financial foundation.

Investments for Kids

3. Mutual Funds for Kids

Investing can be a daunting task for any investor,

Investing can be a daunting task for any investor, but many believe that young investors benefit from setting up mutual fund accounts at an early age.

These investment vehicles act like ETFs by purchasing a bundle of securities attempting to fulfill some stated investment aim.

Mutual funds build portfolios of underlying investments through pooling your money with that of other investors. This creates a larger collection of stocks, bonds and other investments, called a portfolio.

When a mutual fund’s securities’ values change, the net asset value (NAV) is adjusted accordingly by calculating how much more—or less—the fund would have to sell its investments for in order to fulfill shareholder redemptions.

This price changes based on the value of the securities in your portfolio at the end of each market trading day.

Owning a mutual fund in and of itself does not grant the investor ownership to the underlying securities. They only own the mutual fund shares themselves.

Mutual funds come in two types: passively managed and actively managed mutual funds.

Active mutual fund managers buy and sell investments based on their stock research and the investment strategy of the fund. The goal of portfolio management is typically to outperform a comparable benchmark—a commonly used but risky approach.

Passively managed mutual funds simply attempt to recreate the performance of a benchmark index like the S&P 500, Dow Jones or Barclays Corporate Bond Index.

You can invest in mutual funds through IRAs, 529 Plans and ESAs for your children and allow them to reap the long-term rewards of compounding returns in a diversified investment.

Other Assets to Give Your Kids

1. Savings Bonds

When my parents invested for me in the 1990s, they

When my parents invested for me in the 1990s, they did so by purchasing savings bonds in my name. My parents used these to set aside money for me to pay for the costs of college.

Thankfully, once I reached college, I didn’t need the money they had saved for me through savings bonds. I had worked hard enough to earn scholarships and the necessary financial assistance to pay for private college without need for this savings.

I was fortunate enough to not need the college savings my parents had amassed for me. Instead, I cashed out these bonds and began investing in the stock market as a teenager. I invested well enough to use the proceeds to buy my first condo out of graduate school.

But for parents or grandparents who want to save money for their family with these zero risk financial products, you can still do so directly through TreasuryDirect.gov.

You can still cash your unused savings bonds at a financial institution, but you will no longer receive physical certificates.

A savings bond is a great investment because it grows without paying any taxes, but you must pay federal taxes on the bond when redeemed.

The rates on these bonds have fallen dramatically in the last decade, but if you can manage to hold onto them for at least 20 years, the Treasury guarantees doubling your original investment as a minimum.

Consider investing in savings bonds if you plan to start at least 20 years in advance and want a riskless investment. Otherwise, from the investment options covered above, you have more upside potential for providing investments for your kids.

2. Cash

The annual exclusion refers to $16,000 in gifts yo

The annual exclusion refers to $16,000 in gifts you can give to as many people as you want annually.

Married couples can combine their annual exclusions to give up to $32,000 ($16,000 x 2) to as many individuals as they like per year–tax-free.

As a parent, you can provide a financial gift for a child up to the annual exclusion each year without paying taxes. These gifts can help to pay for college, a car, wedding or even a home down payment.

If you gift in excess of the annual exclusion, the value of them counts against the lifetime exemption from estate taxes, which comes to $11.7 million per individual and $23.4 million per couple in 2021.

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Investing for Your Childs Future Expenses and Experiences

Maybe you’re thinking about investing for things that aren’t too far into the future. After all, your children will go through a lot of important—and expensive—events and milestones in their 20s and 30s.

If you want to save or invest money to help your child cover the cost of a wedding or a down payment on their first house, you’ll want to put that money in an account that’s more accessible than a Roth IRA.

These accounts won’t have the time—or tax breaks—to grow like a Roth account, but your kids will be able to use the money penalty-free when they need it for major life events.

1. Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA)

If you don’t plan to touch the money in the account you want to open for your child for five years or more, you can consider a Uniform Gifts to Minors Act (UGMA) or a Uniform Transfers to Minor Act (UTMA) account to invest in good growth stock mutual funds. Here are some of the key things you need to know about these accounts:

  • Just like with a Custodial IRA, UGMA and UTMA accounts are opened in a child’s name and a custodian is named—usually a parent or grandparent. But you can choose anyone to manage the account.
  • The custodian will have full control of the account until the child reaches a certain age.
  • UGMA and UTMA accounts are often used to save for college—after ESAs and 529s—but the money can be used for anything.
  • There are some tax advantages to using UGMA and UTMA accounts. Since they’re in your child’s name, the accounts will be taxed according to their tax bracket. The lower tax rate for children means they’ll pay less in income taxes.
  • There are no contribution limits on UGMA and UTMA accounts.

You probably have some thoughts on how you want your kids to spend the money you’re investing for them. Well, keep this important thing in mind: Once your child is old enough to take custody of the account, they can do what they want with the money. This may be fine with you, but make sure you’re teaching your kids good financial habits so they’ll be prepared when they inherit the account.

2. Brokerage Account

If the idea of basically handing your kids a blank check makes you nervous, you can open a brokerage account in your own name and invest over time until you’re ready to gift the money in the account to your kids. Yes, you’ll have to pay capital gains taxes based on your own tax rates. But you’ll also have full control of the account until you decide Junior is mature enough to handle the responsibility of all that cash.

While brokerage accounts don’t have the tax benefits that come with a Roth IRA, they do offer a lot of flexibility. Since there are no contribution limits, you can invest as little or as much as you want—and you can take the money out of the account whenever you like without penalty.  

3. Money Market Account

Technically this isn’t investing, but money market accounts are really great for short-term savings goals (as in five years or less). MMAs are very similar to savings accounts, but they come with a slightly higher interest rate and require a higher-than-normal minimum balance.

They’re safer than most traditional investing accounts, but that also means they have lower interest rates—so don’t expect great returns. And just like with a brokerage account, you’ll be in control of when and how your kids receive the money you plan to gift them.

Work With an Investment Pro

Ready to start investing for your kid’s future? Get the help of an experienced investment professional to walk you through all the options. Our SmartVestor program can connect you with a trustworthy pro who can help you reach your investing goals.

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