Your child just graduated, and, being a wise parent, you know she'd really like mutual fund shares as opposed to, say, three weeks in
The answer: a cheap one, within a Roth IRA, and preferably one that allows her to add small amounts of money to it over time.
First, prepare yourself. Most graduates will not jump for joy when they get their first prospectus. Nevertheless, your idea is a good one. A
And that's conservative, incidentally. With dividends reinvested, the Standard and Poor's 500-stock index gained an average 11.38% a year the past 40 years, despite periods of sky-high inflation and eight bear markets, two of the face-melting variety. A
Let's start with the criteria for choosing your child's fund, one by one. First: stocks or bonds? That's easy. Even if your graduate is so conservative that he shouts "I'm ruined!" when he drops a nickel down the sewer, he should be in stocks if he's investing for the next 40 years. Over long periods of time -- and 40 years is long -- stocks tend to return more than bonds or bank CDs.
Next: Cheapness is key, especially if you're looking for an investment that will last your child's working life, which should be roughly 40 years. Expenses wilt the value of a long-term investment like rain on a paper mortarboard.
For example, let's say that your grad's fund earns 7%, but management takes one percentage point a year in fees. Your grad's investment earns 6% a year instead of 7%, and your child is left with
You also want to find a fund that will accept a small minimum initial investment, especially if you've just finished paying four years of tuition. For a long time, finding funds with low minimum initial investments was an annoying problem, especially since mutual funds were designed for people of modest means. A
Fortunately, some discount brokerages will let you start with a very low minimum, especially if you're opening an individual retirement account.
And at both brokerages, you can buy a low-cost exchange-traded fund, or ETF, typically without charge.
If you decide on Schwab, consider the Schwab Broad Market ETF (SCHB), which follows 2,500 U.S. stocks and charges just 0.04% a year, or
Finally, you should put your grad's savings into a Roth IRA, which serves two purposes. The first is to shield dividends and gains from taxes, an enormous savings over time. You pay into a Roth with after-tax money, but principal and earnings are free from taxes on withdrawal at retirement, provided you've held the investment for at least five years, and you're 59½.
The second is to provide some small barrier to your grad saying "thanks," selling the fund, and heading to
Your child must have at least as much earned income as the amount you put in. For 2014, the maximum contribution for a single taxpayer earning
Now, a one-time Roth IRA contribution of
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