Traditionally, there have been several options for parents and grandparents looking to make investments for children. But here’s how to choose the best investments for children in 2022.
Taking the time to pick the right investments for children and grandchildren is a worthwhile endeavour. If the child is under the age of 18, she or he cannot yet invest as an adult; however, there are savings and investment options available.
When starting on the road to investing for children, a good first option for you (and the child) is to open a bank account in the child’s name. All of the major banks have special bank accounts for children, usually without service fees on basic transactions. Once the child has accumulated $500, they could move the money into an interest-paying guaranteed investment certificate (GIC).
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In-trust accounts offer low costs and flexibility for child investments
If you want to build an investment portfolio for a child, then an informal in-trust account is a low-cost and flexible option. (Investments or investment accounts in the name of a child must be set up in trust because minors are not allowed to enter into binding financial contracts.) An adult must be responsible for providing the investment instructions and signing the contract on the child’s behalf.
An informal in-trust account has a donor (or “settlor”) who contributes funds to the trust. The trustee is the person in charge of the account, and is responsible for managing the funds for the child (the “beneficiary”). The settlor should not act as the trustee. The settlor’s spouse can be a trustee, however.
The money belongs to the child, but only the trustee can make withdrawals if the child is under the age of 18. Once the child reaches 18, the money is theirs to do with as they wish.
Investments for children should rely on capital gains rather than dividends
Interest and dividend income earned in an in-trust account is attributed to the contributor until the child turns 18, unless the contributor is not related to the child. However, all realized capital gains are directly attributable to the child. So it’s best to downplay investments that mainly provide interest or dividends, and instead hold stocks or ETFs that will earn capital gains.
Exchange-traded funds are among the best investments for a child’s investment account
Exchange-traded funds are some of the best investments to choose as a starting point when building an in-trust account. If you start out with exchange-traded funds, we recommend putting, roughly half of your contributions into a Canadian exchange-traded fund and the remaining half into an exchange-traded fund holding U.S. stocks. ETFs, with their relatively low management fees (MERs), have in large part eclipsed interest in mutual funds. As well, regulatory changes in Canada force brokers to disclose all the costs associated with mutual funds and other similar investments. That should further increase the appeal of ETFs.
2 things to avoid when making ETF investments for children
1. Get out of “theme” ETF investing
It pays to stay out of narrow-focus, faddish funds, all the more so if they’ve come to market when the fad dominates the financial headlines.
Trendy theme funds like these face a double disadvantage, because they appeal to impulsive investors who pour their money in just as the fad hits its peak. This forces the manager to pay top prices —and perhaps to bid prices higher than they’d otherwise go—even if this goes against their better judgment. When investing for children, you’re buying for the long term, so hot theme funds, where investors are apt to flee when prices hit their lows, often force the mutual fund managers to sell at the bottom. That, of course, lowers the ETF’s performance. When fads die out, as they all do, the fund’s liquidity typically dies out with it. The manager may have to dump the mutual fund’s holdings when demand is at its weakest, forcing prices lower than they would otherwise go. Investments for children are meant to be long-term; fads never are.
2. Get rid of ETFs that show wide disparities between the ETF’s portfolio and the investments that the sales literature describes.
Many ETF operators describe their investing style in vague terms. It’s often hard to find out much about who is making the decisions, what sort of record they have, and what sort of investing they prefer. We always take a close look at an ETF’s performance and investments to see if they differ from what the prospectus or sales literature would lead investors to expect. For example, it may suggest broad diversification, but it may in fact hold a disproportionate amount of mining stocks. Our advice: When an ETF takes on a lot more risk than you’d expect, you should get out. That applies to investments for children, as well as investments for established investors.
What other investments for children have you made?
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