There is a significant difference between saving and investing. Saving involves the periodic or systematic setting aside of funds in a safe, secure location that is easily assessable, such as a savings account in a federally insured bank. Investing involves the ownership of an asset and typically involves a certain amount of risk, which may be slight or great depending on the investment. There are a number of factors to consider when investing money for your children in securities such as stocks.
There are certain financial basics that you should consider whether you are investing for your own account or your child's account. Creating a sound financial plan is a lot like planning a trip. You must know where you are, where you want to end up and how you plan on getting there. Your balance sheet can tell you were you are, your financial goals can tell you where you want to end up and your budget can help with decisions about how to get there. Before creating a stock portfolio for your child, you should set the goals you wish to attain for your child, create a balance sheet and develop an investment budget for her.
Your financial goals for your child will play a significant role in determining the best stock portfolio for her. If your goal is to set aside funds for your child's college education, you may wish to establish an individual retirement account for your child. You can contribute an amount equal to 100 percent of your child's earned income up to the limits prescribed by law, which was $5,000 as of the time of publication. You can use the funds in the IRA to purchase individual stocks or mutual funds. Those investments can grow tax deferred until they are withdrawn. Your child will pay taxes on all funds withdrawn from a traditional IRA and on the earnings portion of funds withdrawn from a Roth IRA, but if your child uses the funds to pay for qualified expenses for higher education she can avoid the IRS's 10 percent tax penalty.
If you wish to teach your child how to invest, but you want to maintain control over the child's stock portfolio, you may wish to open a custodial account. You control all buy and sell orders in a custodial account and you have the ability to use the funds in the custodial account for the benefit of the child until she reaches her majority, which is typically 18 years of age. Custodial accounts do not have the tax benefits of IRA accounts, so you will have to deal with capital gains or losses on trades, and any dividends produced in the custodial account will be taxable. Once your child reaches her majority, the portfolio belongs to her to do with as she pleases.
The type of stock portfolio that is most appropriate for your child is the one that best meets her investment objectives. Most Americans do not have sufficient funds or the expertise to develop a properly diversified portfolio on their own. Mutual funds can provide both professional management and a well diversified portfolio in a single security. Mutual funds are required by law to disclose both their investment portfolio and their investment objective. By carefully reading a fund's prospectus you can determine whether the fund's objectives match your child's investment objectives.
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