This holiday season, skip the mall. If you have kids in college, help give them a leg up financially, and teach them how to grow their money over time. Here are three ideas:
Automatic savings account. The average interest rate on a savings account right now is comparable to what you would receive if you buried your money in your backyard. This year, teach your kids how to accrue more money with two fairly new options from Wachovia, Wells Fargo, and Bank of America. All it takes to set up an account is a trip to your local bank branch and a little paperwork.
Wells Fargo and Wachovia both offer customers the Way2Save account. Here's how it works: Each time they swipe their debit card, the bank automatically transfers a dollar into their Way2Save account from their checking account. A bonus is that for the first year, the account provides a 5 percent annual interest rate along with a 5 percent bonus on the one-year anniversary of the inception of their Way2Save account. Both banks allow them to set up automatic monthly deposits also.
Another option is Bank of America's Keep the Change program. Every time your kid makes a purchase with a debit card, the purchase is rounded up to the nearest dollar, and that change goes into a Bank of America savings account. Bank of America also matches the first three months of contributions made to Keep the Change accounts penny for penny (up to $250) and matches 5 percent after that time.
Mutual funds. Whether you have $1,000, $100, or even $0 available to invest upfront, there are plenty of options for investing. Set up an automatic monthly investment plan for your kids where you contribute a certain amount to their accounts per month. (Use Morningstar's mutual fund screener to search for funds with low minimum investments.) "It's good to get young people thinking about expenses and investing," says Morningstar analyst David Kathman.
One way to set up a diversified portfolio with only one fund is to put money into what are called funds of funds, which invest in a handful of underlying funds. Two examples include the Vanguard STAR fund (VGSTX) or T. Rowe Price Spectrum Growth fund (PRSGX). With one fell swoop, your son or daughter could have an investment in nine or 10 different funds. Funds of funds offer diversification and fairly low fees because of their simplicity. T. Rowe Price's Spectrum Growth fund, for example, invests in 12 other T. Rowe Price stock funds. An initial investment of $500 and $50 per month for a 20-year-old would result in $188,000 if they pulled their money out 40 years later, with an estimated rate of return of 8 percent.
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Roth IRAs. Consider giving your kids a Roth IRA because a small investment in their early 20s can pay off big when they're nearing retirement. Your local financial adviser can set them up with a smart investing strategy.
Roth IRAs differ from traditional IRAs. Both offer tax-free growth, but Roth IRAs allow you to take money out of your account tax free after age 59½. Patrice Sinclair, who is a certified financial planner and senior vice president of investments of the Auburn Hills, Mich., branch of Raymond James & Associates, says that at such a young age, most people should consider investing in a combination of stocks and bonds depending on their risk tolerance. "There is really no other place in the tax code where they can get that kind of growth with that kind of benefit," Sinclair says. "Compounded gains with no tax—you just don't get that benefit very often, so if you can do it, it can be a real good thing."
There are various stipulations and restrictions to opening a Roth IRA, but here are the basics. To open a Roth IRA, you have to have some sort of income. Instead of giving your kids a gift certificate, write them a check to open a Roth IRA. Parents can't invest more than what their kids make in a given year, but parents can invest up to $5,000 a year. There are restrictions on what investors can and cannot do up to age 59½. Investors are free to take out contributions, but not earnings (which results in a fairly large tax penalty) until age 59½. So the goal here is long-term, leave-it-alone investing.