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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
•
Bankrate.com |
Where should my kids invest?
Dear Dr. Don,
Both of my daughters have $5,000 invested
in a 3 percent savings account at our local credit union. Is this
the best method for investing long-term?
Current CD (certificate of deposit) rates are even
lower than the interest rate that they have now! I don't care for
the stock market seeing how my daughters' accounts of $300 each
were invested four years ago and the average balance has always
been lower than the amount invested!
Thank you,
Pamela Percentage
Dear Pamela,
Savings accounts are seldom the answer to meeting long-term
financial goals because the returns don't keep pace with inflation.
Still, earning 3 percent annually on a savings account is better
than being down 9.18 percent, the average annual return of the Standard
& Poor's 500 for the three years ending June 30, 2002, which
is no doubt the reason why you've had no success with the children's
stock investments.
Children under the age of 14 can earn up to $1,500
in income on their investments at their tax rate before they're
subject to your tax rate, called the "kiddie tax." The
$150 they earn annually on these savings accounts isn't going to
trigger that tax.
IRS
Form 8615 provides all the details about the "kiddie
tax." What's important about this information is that you don't
have to rush out and replace these accounts with tax-advantaged
accounts for your girls.
For a guaranteed return plus inflation protection,
it is hard to beat the Treasury Inflation Protected securities (TIPS)
or the Series I savings bonds. The U.S. Treasury just auctioned
a 10-year TIPS note in July. The note had a coupon rate of 3 percent
and was priced to yield 3.099 percent.
Interest payments and the principal paid at redemption
are indexed to changes in the Consumer Price Index (CPI). The Treasury
also offers a five-year and a 30-year maturity.
You can buy these notes at auction through the Treasury
Direct program and avoid paying a brokerage commission. The
minimum investment is $1,000 and the securities are sold in multiples
of $1,000.
These securities will fluctuate in price with changing
expectations about future inflation and changes in interest rates,
but there is no default risk with these securities. Inflation-indexed
notes are usually announced at the beginning of January, July and
October and auctioned on the 15th of the month. If the 15th falls
on a weekend or a Federal holiday, the securities are issued the
next business day.
The tax treatment of TIPS is more complex than that
for the girls' savings accounts. IRS
Publication 550, Investment Income and Expenses, can help
with the tax treatment of these securities.
The fixed-rate component of the Series
I savings bond has dropped dramatically over the past few years
to the point where, if you're willing to put up with the tax reporting
requirements on the TIPS, I think they are the better choice. Especially
when using the Treasury Direct program.
However, the Education
Savings Bond Program would allow you to buy bonds in your name
and the investment income would be tax-free if the bonds were redeemed
for qualified educational expenses. (There are income limitations
for you to qualify for this program.)
So, for a guaranteed return with inflation protection,
turn to the inflation-indexed securities offered by the U.S. Government.
-- Updated: Nov. 11, 2002
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