Giving Money to Your Adult Children? Use It as an Introduction to Investing
by , CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
September 30, 2009
I am investing $5,000 for each of my two daughters who have graduated from college. What are your suggestions?
Giving your adult children some capital for their future is a wonderful gesture, and even more so when the gift has the potential not just to grow but to become an important learning experience. And that's why my suggestions today focus less on what
to invest in (that depends on a lot of factors, discussed below) and more on how
to turn this gift into a great opportunity to teach your daughters about investing.
For the benefit of other readers, there's no gift tax on a gift of $5,000. In fact, you can actually give anyone up to $13,000 per year without triggering gift taxes, as can your spouse. I assume you're planning to set up accounts for your daughters in their names using their own Social Security numbers (so be sure to let them know that the money is not only theirs to own—it's also theirs to manage and be responsible for). And then I'd make it clear to them that you're making an investment in their future, and that you hope they'll use the opportunity to learn a bit about investing and the financial markets at the same time that they build a nest egg. Following are some things to discuss.
- Goal-setting: Investment success is a lot easier when you have a well-defined goal (or set of goals) with a specific time horizon. Let's say one daughter wants to buy a house in five years, while the other plans to invest for a long-term goal like retirement. Clearly, the investment decisions each would make would be quite different. House-hunting daughter should probably be very conservative with just five years to go before she needs the money, while the retirement-planning daughter might be willing to take on more risk with a 25- or 30-year time horizon. Understanding these trade-offs is crucial, and helps guide the decision-making process.
- Asset allocation: When their goals are clear, you can start teaching your daughters about how to use the major asset classes to reach them: stocks (domestic and international) for potential growth, bonds for income and to add "ballast" to a portfolio, and cash for safety and liquidity. Portfolio construction begins here, by determining the mix of the three asset classes that reflects each daughter's goals and time horizon. The longer the time horizon, the more aggressive they can be.
- Risk tolerance: This is a tricky one, because everyone is going to have a different sense of comfort with risk. Most new investors need to familiarize themselves with the various risks associated with different investments, and understand the tradeoff between risk and reward. Your daughters will need to consider their individual tolerance for risk as well as their time frames as they make investment decisions. You can play an important role in helping them make the best choices.
- Portfolio construction: When you've figured out goals, time horizons, asset allocations, and risk tolerance, the fun begins: building a portfolio. There are quite literally thousands of ways to do this, from simple-to-use target funds to low-cost index funds, to actively managed mutual funds, to individual stocks. With $5,000 to start with, funds seem a practical choice because many have low costs and offer a high degree of diversification. Engage your daughters in the process, and they'll feel more connected with their portfolios—and more likely to pay attention to them going forward.
- Periodic review: Once a portfolio is created, it's important to keep tabs on its progress. Obviously, your daughters will be interested in the basics: Did I make money or lose money on my investments this quarter or this year? But the more important issues are these: How did my investments do relative to their benchmarks? Is my asset allocation still in line with my target (things can get out of line when asset classes are volatile)? And have my goals changed in a way that would necessitate a change in my strategy?
Again, I salute your impulse to invest on your daughters' behalf. But I urge you to seize this moment. Transform the act of giving into an opportunity for learning for your daughters. They'll thank you for years to come. Good luck.
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