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Now may be the perfect time to introduce a child or grandchild to the
stock market by giving the gift of dividend reinvestment plans.
Its never too early to start an investment program. Whether youre five years old or 50, if youre not in the game, theres never a bad time to start.
The following examples should give you an idea of just how important time is to investment success:
A 22-year-old who starts investing $50 per month will have nearly $319,000 when he or she turns 62 (assuming an average annual market return of 10%). If that 22-year-old waits 10 years before beginning an investing program, he or she will have to invest almost triple the amount (or approximately $140 per month) to achieve the same $319,000 result.
Lets say that you want to fund the retirement program of a newborn child or grandchild. If you invest $4,000 around the day your child or grandchild is born and never touch the investment again nor make another contribution that $4,000 will grow to nearly $1 million by the time the child turns 65 years old (assuming a 9% annual return).
I stole the following example from The 7 Secrets of Financial
Success, written by Jack Root and Douglas Mortensen and published by Irwin Professional
Publishing. In 1626, the Native Americans sold Manhattan Island for the equivalent of $24.
Had the $24 been invested and earned an average annual rate of return of just 7.2%, that
$24 would now be worth more than $3 trillion (of course, none of us has a 370-year
investment horizon, but you get the point).
Since time is so critical to investment success, the more time you have, the better off you are. A 10 year old who starts setting aside money today will be tomorrows millionaire. Look at the numbers: A 10 year old that invests just $10 a month perhaps money earned from a paper route or doing chores around the house, or perhaps funds accumulated from birthday or holiday gifts will see his or her funds grow (assuming an average annual return of 10%) to more than $174,000 by the time he or she reaches age 60. In other words, that total investment of $6,000 over the course of 50 years becomes $174,000. And if he or she can pony up (with a little help from mom and dad) $50 per month, that investment of $30,000 over a 50-year period will turn into more than $873,000.
Notice that a key component in this investment equation, in addition to time, is the annual return on your investment. I assumed a 10% average annual return roughly the long-run average return of the market. In order to achieve that return, juniors money will have to be invested in stocks. Unfortunately, all too often a childs money ends up in a savings account or certificate of deposit not bad investments, mind you, but investments destined to under perform stocks over the long term.
DRIPs - Perfect Investments For Kids
Dividend reinvestment plans represent an excellent way for youngsters
to exploit the power of time in an investment program while earning returns well above
DRIPs have several advantages for youngsters. Since most dividend reinvestment plans have small minimum investment requirements Coca-Cola, for example, allows DRIP participants to buy stock with just $10 a child or grandchild should have the financial wherewithal to make periodic contributions. Having a youngster kick in to his or her own investment program is critical in order to get involvement and commitment to the program. And since you deal directly with the company, the child does not have to go through a broker nor endure broker calls.
It is easy to set up an account for a child or grandchild. Companies
offering no-load stock plans offer the easiest way to get started since initial shares can
be purchased directly from the companies. If you buy the first share of stock through a broker in
order to enroll in the DRIP, make sure the stock is registered in an individuals
name, not the "street name."
Another way to get a child started is the "buddy system." Lets say that you already own shares in Coca-Cola. You can transfer one of your shares from your account to an account set up for your child or grandchild, thus making him or her a registered shareholder and eligible to join the plan. Transferring shares is easy. Just secure a "stock power" form from a broker or the companys transfer agent. Fill out the stock power form. When youve done this, take the form to a bank to receive a "medallion" signature guarantee. Once the form has been stamped with the medallion, return it to the transfer agent. You might want to include a letter stating your intentions and specifying that you would like to enroll the individual directly into the dividend reinvestment plan. Most companies will oblige. The process costs little or no money to complete and is very easy.
Registering the stock, whether you invest directly via a no-load stock plan or go through the broker to get the first share, is an important consideration when starting a child in the plan. You could merely open up an account in your own name. In this way, you control the plan. However, disadvantages to this approach are that you will be taxed on income earned in the plan at your tax rate.
An alternative is to set up the plan in the childs name under a Uniform Gifts to Minors Account (UGMA). Funds in the account are in the minors name and social security number and are considered to be owned by the minor. Dividends paid on the account are taxable, most likely at a preferred tax rate. The adult custodian is responsible for the account until the minor reaches the age of majority. Any withdrawals from the account are payable to the custodian on the minors behalf until that time. However, once the youth has reached the age of majority 18 in many states control of the account reverts to him or her to do with as he or she sees fit. This is the downside of setting up a UGMA. Parental control is lost at the age of majority. Hopefully, by the time a child reaches 18, the principles of investing are so ingrained that he or she would be reluctant to squander funds that took so long to accumulate. Nevertheless, it is important to understand the pluses and minuses of UGMAs before registering the shares in that form.
Picking The Right Stocks
Many companies which may be familiar to youngsters offer DRIPs. The
following table highlights a number of quality companies offering DRIPs which should be
appealing to a child or grandchild.
This aspect of DRIP investing for children is especially important. I think involvement and commitment can be accentuated if a child invests in a company in which he or she is familiar with the firms products and services. A child may lose interest if his or her investment is in some company to which the child cannot relate. On the other hand, a child will likely have a great interest in his or her investment if, say the next time he or she goes to McDonalds or visits a Disney theme park, he or she understands that he or she is an owner of the company.
Before investing, make sure you obtain a DRIP prospectus so there are no surprises when enrolling a youngster in the plan.
|DRIPs for Kids||Optional Cash
Minimum & Maximum
| Disney (Walt) (NYSE: DIS)
| Exxon (NYSE: XOM)
|Harley-Davidson (NYSE: HDI)
| Hershey Foods (NYSE: HSY)
| Home Depot (NYSE: HD)
| Mattel (NYSE: MAT)
| McDonalds (NYSE: MCD)
| Wal-Mart Stores (NYSE: WMT)
Initial purchase may be made directly from the firm.
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Life In Financials
Charles Carlson, CFA
Editor, DRIP Investor
One group that I believe will lead the market in the near term is the financial sector . . .
This directory covers over 600 dividend reinvestment plans, including the ones that can be purchased directly from the company.
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