Ask the Dollar Diva By Dorothy Rosen • Bankrate.com

The gift that keeps on giving

Dear Dollar Diva,
My son is 2 years old and receives checks as gifts for holidays and birthdays, and from his grandmas. We set up a certificate of deposit and a money market account for him, but I feel we could do more with his money. I do not want to take a lot of risk, but I am sure his money could earn more elsewhere. Could you suggest anything?

Congratulations to those smart people who are giving checks instead of things to your baby on those happy occasions. Your son will render useless his clothes and toys, but the earnings from the cash gifts will continue to grow and compound as the years go by.

You are right -- his money could earn more elsewhere. The bad news is higher earnings usually mean higher risk. The good news is higher risk isn't so bad for a 2-year-old.

Mutual Funds

Mutual fund managers pool money from many investors to buy a portfolio of securities. This allows the individual investor to have a diversified investment portfolio for a relatively small amount of money. The Diva recommends buying no-load funds from a reputable investment firm such as Fidelity Investments, T. Rowe Price, Stein Roe or Vanguard. Here is a sample of funds:

To help you decide what type of fund to choose, the Dollar Diva offers a rule of thumb: The longer you expect the money to be invested, the higher the risk you can afford to take. If you think your son will need access to the money within the next five years, go with a lower-risk fund. If not, go with a moderate- or higher-risk fund.

The initial investment required will vary. Expect it to be in the range of $500 to $2,000. You may get away with a lower minimum in a Uniform Gift to Minors account. However, there may be a charge if the balance falls below that minimum, so check that out. If you don't have enough for the initial investment in the fund you select, keep saving the way you are until you do. You have plenty of time -- the funds will be there when you're ready to invest. Never rush into an investment, and never invest in a fund until you have read the prospectus. You can get a prospectus online or by mail.

Stein Roe Young Investor Fund

One fund that's geared to kids is the Stein Roe Young Investor Fund. It's a no-load growth fund that has two missions: investing and educating. The young shareholders receive educational materials on economics and personal finance to help them understand the financial aspects of the world they live in. The minimum initial investment is $1,000.

Index Funds

If you absolutely haven't a clue as to what mutual fund to choose, select the category you are interested in (such as growth-and-income), and put your son's money in an index fund made up of securities in that category. For example, Vanguard's Index 500 Fund is a growth-and-income fund that invests in the same 500 companies as the S&P 500. Its administrative fees are well below 0.25 percent because the stocks are selected by the market, not the fund manager. There are index funds in every category, including bond funds, equity funds and equity-and-income funds. Vanguard is the index fund leader, but you will find other companies selling them too.

Individual Stocks

Kids love owning stock in companies they understand, such as Coca Cola, Wrigley, Disney and toy companies. You can call, write or visit a company's Web site for information and to get copies of their annual reports. Some companies have dividend reinvestment plans called DRIPS, where you can buy and sell shares directly from them and save transaction fees. ValueLine publishes a good tool for evaluating stocks, "The ValueLine Investment Survey," which can be found in most libraries or -- for a fee -- online.

U.S. I Bonds

For low risk savings that adjust for inflation, the Diva likes the new U.S. I Bond. Some of its features are:

• Currently paying 3.3 percent fixed rate plus a 1.72 percent inflation adjustment for a total return of more than 5 percent. The 3.3 percent fixed rate remains constant over the life of the bond; the adjustment for inflation is made every six months.

• You don't need a lot of money to buy a bond. They come in denominations of $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000.

• You don't pay federal income tax on the bond's interest until you cash the bond. Compounded, tax deferred earnings for up to 30 years -- the Diva's favorite kind!

• You never pay state and local income taxes.

• If you redeem the bonds during the first five years, there is a penalty equal to three months of interest.

• They will not qualify for the higher education exclusion if they are in the baby's name.

DOROTHY ROSEN has a master's degree in finance, with a specialization in accounting, from the Kellogg Graduate School at Northwestern University in Evanston, Ill. Rosen has more than 15 years of experience in the financial arena, serving in Illinois and Florida as a certified public accountant, financial consultant, expert witness and educator. She is owner of Dorothy Rosen, CPA, a public accounting firm that serves individuals and small businesses.