It’s important to teach your children about money while they’re still young. That means teaching them good habits and teaching them how to make money. Since many people don’t have good spending habits and don’t invest, it can be hard for them to teach their kids either one of these things. It’s really important to recognize that talking to your children and telling them how to handle money isn’t enough. Kids aren’t dumb, and they learn as much by observing their parents as they do by listening to them. That’s why it’s crucial to make the process of shopping for anything with your children long and tedious. Even if you’re well off, you need to teach your children how to comparison shop. If you’re buying them toys or clothes, or anything else for that matter, make your kids consider the price of what you’re buying and have them look for better deals, even if you don’t end up taking them and even if the price doesn’t matter to you. If there’s something your child really wants, make him or her do some research about it online before you agree to buy it. Just getting your kids into the habit of being careful with their purchases can really help them later in life. I like debit cards too as a method of teaching. Nothing teaches kids to budget better than to run out of money on a debit card.
Of course, I think the most important thing to teach your children about money is the value of investing. Many parents teach their kids about the value of saving money, often by setting up a bank account under the child’s name and showing them how interest works. This is fine because the compounding of interest is like the eighth wonder of the world and I want everyone to see it. But I think you can do better than that: set up a brokerage account for your children and buy one share of a stock that I recommend later in the book. Try to pick one that your child might actually be familiar with, such as McDonald’s. The trick here is to get the child interested in the stock market so that he or she has a heads-up about what it is all about. Recently I taught a high school class—a sophisticated one at that—about stocks, and I was shocked that most students had no idea how stocks work. Owning one share will change that. For those who think that’s excessive, you don’t actually have to set up a real brokerage account. Instead, you can create a rotisserie league of stocks, where you draft some stocks and your kids draft some stocks using a limited amount of play money. The winning stock gets bought and put into the child’s account. This is a much more powerful lesson than starting a bank account. Investing in stocks will make you a lot more money than keeping your money in the bank, and when your kids see how much they can make by investing, especially if you teach them about this at a young age, they’ll be really impressed. You don’t want your children just saving money, because saving isn’t all that valuable if you don’t invest. Plus, this is an opportunity for them to learn about losing money without it being too costly.
One more thing: many parents exclude their children from family discussions about money, and I think that’s counterproductive. I admit I have been guilty of this. I have never wanted my kids to know my financial status. But when I give them an inkling about what I do with the money I make, they are fascinated. If you can talk to your children about the family finances, they’ll get a much better understanding of how money works and how real people go about paying for the things most children take for granted. I also think that when you buy one share of a stock for them, it allows the discussion to go much easier. It also gives them a place to save when they make a little money besides what is in the passbook. I am grateful that my local bank, Commerce Bancorp, actually gives kids passbooks, but I would rather they had stock accounts to get rolling in the greatest investment possibilities we have in this country.
When I talk about getting kids involved in the market, I mean getting them involved in things they know and may get excited about. I can’t stress how vital it is to get your kids excited about their holdings. I used to grab that newspaper out of my dad’s arms each night when he came back from work just to see the closing prices of stocks that I was following on paper. What I wouldn’t have given for those stocks to be the real thing. If it were possible back then, I would have gone online at each close to chart how my stocks were doing.
But to capture the fancy of little kids, kids as young as 6 years old, you need to find some top-notch brand names that you know and like and that your kids will naturally be able to follow. That way you can constantly refer to your child’s holdings and get him or her comfortable with the idea of actually owning a piece of a company. You will be ingraining the process and making it fun. I have come up with a list of six stocks for kids under 6. I would buy one share of one of these the moment your child is born, and add another share a year later, or perhaps pick another one of the stocks and buy a share of that. I don’t know a soul who is doing this, and that has to change, right now. Any unearned income less than $1,700 can qualify for UGMA (the Uniform Gifts to Minors Act) status, which allows your kids to make money owning stocks without paying the same level of taxes that you pay. That’s why buying your kids stocks in small increments is so great; they’ll get the gains without having to give them back to the government.
Stocks for Children Under 6
1. Disney. Here’s a company that every child will recognize, from its dominance of animated films courtesy of its Pixar acquisition, to its Disney Channel full of programming. All children like to go to the parks, and this will become a much bigger deal over time if you buy a share now. Disney foundered for a long time under inferior management, but the change a few years ago to Bob Iger, the new CEO, has meant the world to this company. He instituted a buyback, solved the animation woes, and backed incredible franchises like Pirates of the Caribbean, The Chronicles of Narnia, and High School Musical. The TV division, including the amazing ESPN franchise, has been a huge cash cow even in a time when everyone records the programs and skips the advertisements. You just can’t record ESPN and play it later. This is a premium name that can get a kid more involved than just about any other publicly traded company.
2. Viacom. This is a cheap stock that has been down on its luck ever since it split from CBS. It has some fabulous properties that will appeal to children, notably Nickelodeon, the foremost place for cartoons and kids’ entertainment. MTV, which your kids could catch onto pretty early, has developed some programming about teens that young kids want to watch. Meanwhile, the Paramount film studio has some pretty remarkable kids’ movies, including the ones that take advantage of characters that will be familiar to your kids, Jimmy Neutron and SpongeBob. The stock is cheap, management is emboldened to meet goals—they just had their first head-count reduction because the company had become fat and bloated—and they are buying back stock aggressively. You want your kids to own shares in SpongeBob for certain.
3. Hasbro. Kids love toys like Mr. Potato Head; they love Parker Brothers games; they like Tonka trucks and Milton Bradley products. Monopoly, Sorry!, the Game of Life, Twister, My Little Pony, Toy Story toys, everything that you will be playing with them from day one. I believe 2007 will be the year that Mattel took itself out of the running because of issues with its Chinese toys. Hasbro doesn’t have that problem. The stock has been cheap despite consistent growth. I don’t know about you, but board games were the way I connected with my folks. I would love to own a piece of Boardwalk or Park Place; so will your kids.
4. Gap. Gap is in the midst of one of the biggest turnarounds I have ever seen, and one look at GapKids tells you that they have at last gotten it together. I think that the new management, brought in from outside Gap, is engaging in a long-term turn that will mean you and your kids will be shopping there together. Plus, you need to have some stock that’s down on its luck, and where I think a turnaround is at hand, so the risk is out of the stock. The worst that can happen is that Gap gets taken private before your kid gets to shop there—but certainly after you’ve bought a ton of infant clothes for him or her.
5. Gymboree. Not just clothes—that’s how I look at Gymboree. It has play programs for children that make the company money. It a
lso has play and music and art classes, something that first-time moms have fallen in love with. This is a company that also understands fashion; it’s like an Abercrombie or American Eagle for little kids, with truly fashion-forward choices. Gymboree has always had a strong reputation with girls, but recently its boys’ clothes have come on strong. Meanwhile, the chief competition, Children’s Place, has been hurting, in part because of a chilled relationship with Disney that had previously spurred sales. Just as Hasbro is profiting from Mattel’s misfortunes, Gymboree is benefiting because of weaknesses at Children’s Place. This company may be the most likely stock to own if you, like millions of others, are a mall shopper.
6. McDonald’s. This is one of my favorite stocks, one that I consider to be great for the ages. I don’t know a parent who hasn’t taken a kid to McDonald’s, if only just for their clean bathrooms. When I was growing up, McDonald’s stood for bad food; now it has tons of healthy offerings. Its kids’ promotions make it a rival of Disney as the first company name that kids think of.
Any of these companies will work. I urge you to buy one share of one of these, and perhaps talk your parents into doing the same for their grandchild. If only baby showers would get registered with E*Trade, TD Ameritrade, and Schwab! And don’t forget to reinvest those dividends. I can’t ask you to explain compounding to a child, but the brokerage statements will help you do that.
When I was little, the first thing my folks got me was a passbook. The second thing was a savings bond. These yawners never encouraged me to do anything or follow anything. They should be banished as bad alternatives to stocks.
One more thought about stocks for children. I want to encourage you to speculate with a stock that seems like a highflier, whatever the highflier might be at the time. Why? Consider the five best performing stocks in the past twenty years, the time frame I use to make decisions for my kids: Oracle, the software company, up 13,064 percent; Harley-Davidson, motorcycles, up 7,603 percent; Microsoft, software, up 7,308 percent; Paychex, the payroll service company, up 6,838 percent; and Amgen, the biotech company, up 5,850 percent. Let’s look at it another way, the price a stock would have been twenty years ago considering all the splits: Oracle, 15 cents; Amgen, 64 cents; Harley-Davidson, 71 cents; Microsoft, 38 cents; and Paychex, 65 cents. In other words, don’t freak out if you pay $40 or $50 for a stock that is speculative. Look ’em up; look where the speculative stocks of twenty years ago got to!
More important, consider the categories worth speculating in: software (Oracle, Microsoft), biotech (Amgen), leisure (Harley-Davidson), and services (Paychex). You match one of these blue-chips with a speculative stock that could be a flier like every one of those best-performing stocks, and your kids could end up using their profits to pay for an education that you thought you’d get stuck funding.
Paying for College
There are a lot of great ways to save on paying tuition. I know that many personal finance authors advise parents not to pay for their children to go to college until after they’ve taken care of their own retirement fund. I agree that retirement is priority number one, but I don’t see why you can’t save for retirement and help out your children with college tuition at the same time. The best thing you can do for your children, at least financially, is to pay to send them to college. That way your kids won’t be burdened with student loans when they graduate, and because they’ve gone to college they’ll be able to get better-paying jobs. It’s important to teach your kids about money, and I’ll explain how I would handle that after I tell you how to save on tuition, but even if your children don’t grow up learning how to handle money perfectly, giving them a free ride through college—which I admit doesn’t do much to teach them the value of a dollar—will really help with their future and perhaps aid them in taking risks that could produce much larger rewards later in life than if they were worried about every dime when they’re in their 20s.
To make college more affordable, you’ve got two great savings plans, Coverdell Education Savings Accounts and 529 Savings Plans, two plans that I sure wish my folks had had when I was planning to go to college. Both of these plans have a lot in common with a Roth IRA, in that you contribute to them with after-tax income, but once your money is in the account it grows tax-free and distributions from the accounts are tax-free. With a Coverdell, you can contribute up to $2,000 a year, and you decide how to invest the funds you keep in the account. You can withdraw money from a Coverdell at any time, but withdrawals are tax-free only if you use them to pay for qualified education expenses. That covers more than just college expenses. A qualified education expense can include any costs related to attending a primary school, a secondary school, or college. If you withdraw money from a Coverdell and spend it on noneducational expenses, it will be taxed at ordinary income tax rates, and you’ll also pay a 10 percent penalty, just as you have to pay for withdrawing money from a retirement account before retirement. Clearly, you shouldn’t start a Coverdell if you don’t intend to spend every penny you put in there on paying for education. Money in a Coverdell Education Savings Account isn’t considered by colleges when they calculate the level of financial aid they’re willing to provide. That’s a really important, really terrific benefit. Unfortunately, you can’t contribute to a Coverdell account if you’re too rich. For a married couple filing jointly, the phaseout starts when your adjusted gross income hits $190,000, and once it reaches $220,000 you won’t be allowed to contribute anything. You also can’t use a Coverdell to pay for education expenses once your designated beneficiary turns 30, so make sure your kids go to college on time. There’s one more problem, which is that some of the provisions that make Coverdell accounts helpful are set to expire in 2011, but I really don’t believe Congress will let this happen. This is the kind of plan that gets bipartisan support because it appeals to everyone. Republicans see these plans as lowering taxes and Democrats see them as giving lower-income families a better way to pay for education. If you don’t take advantage of a Coverdell plan, you really are costing yourself a lot of money.
If you’ve got too much money for a Coverdell account, you can use a 529 Savings Plan. These plans come in two different forms. There are 529 Savings Plans and 529 Prepaid Tuition Plans. The savings plans are run by states, and the prepaid tuition plans can be run by states or educational institutions. With a prepaid tuition plan you can buy tuition credits at today’s rates and use them to cover tuition when your child goes to college. We all know that college is becoming more expensive, but I’m not sure that the price of college is increasing fast enough to justify prepaying tuition rather than contributing to a 529 Savings Plan. In a 529 Savings Plan you can invest your contributions, which are made with after-tax income. You pay no taxes on your gains and no taxes on withdrawals from the account that are used to pay for college. Compared to Coverdell accounts, 529s have a lot of drawbacks. The only thing about a 529 plan that’s better than a Coverdell is that it lets you contribute a whole lot more money. Maximum contribution levels vary by state, and you want to start a 529 in your state of residence because you’ll get more tax advantages that way, but the maximums are always quite high. You can contribute at least $230,000 a year to a 529 plan, and some states allow you to contribute up to $300,000. However, there’s a drawback to contributing this much: you might have to pay a gift tax because this account names one of your children, not you, as a beneficiary. But even with a gift tax, you get a break from 529s, although a much smaller amount than those gigantic contributions. For 2007, you’re allowed to give individual gifts worth up to $12,000 tax-free, and you can give twice that amount as long as you’re married and file a joint tax return with your spouse. But in a 529 plan, you’re allowed to contribute a lump sum of up to $60,000 in one year, and you won’t pay any gift tax on that contribution as long as you take no gift tax exemptions for the next five years. You can use the money in a 529 to cover tuition, room, board, books, school supplies, and any other costs necessary for college, and you can always
change the beneficiary of your plan without paying a fee. Don’t blanch; school is a lot more expensive than when you went! (If you are a student now, you know exactly what I am talking about.)
While 529 Savings Plans do a great job of letting you contribute huge sums of money, they’re like the 401(k) plan of the college savings world. Just as with a 401(k), you don’t get to manage your own 529 account. Instead, your state of residence will offer a set of investment plans that are run by mutual fund companies or other financial services companies. The offerings in 529 plans are similar to the mix of undesirable mutual funds you might find in a 401(k) plan, which is a definite drawback. Plus, many states allow the companies that run their 529 programs to charge enormous fees. States will offer more than one plan, and they’re all required to offer a no-fee, low-cost plan, but that plan might not have many good options. My advice is to first max out your contributions to a Coverdell Education Savings Account, and only after you’ve done that should you look at a 529 plan. You should use the plans offered by the state you live in, because they’ll typically give you state tax breaks for the money you contribute. Look through all the plans your state offers for one with low fees and some decent funds. You’re probably best off looking for a low-cost index fund rather than hunting for an actively managed fund that will consistently beat index funds. Once again, a good S&P 500 index fund is the right default option for most of you. You’ll have the opportunity to contribute to bond funds as well, but I don’t think that’s necessary for an account designed to pay for college. Remember, this is basically money for your kids, and they’re going to be young when they go to college. I don’t recommend owning any bonds until you hit your 30s, and you shouldn’t have your kids invested in bonds through their 529 plans. Sure, stocks are more risky than bonds, but it’s not the end of the world if your children have to take out some student loans or rely on financial aid to fully pay for college. That was my ticket: scholarships and loans. They can be your kids’ ticket too. This isn’t like retirement, where you have few other options if your retirement fund gets wiped out (which is why you have to invest more and more of it in bonds as you get older).
Jim Cramer's Stay Mad for Life Page 16