How can I invest for my grandchildren on a few hundred dollars a year?

A couple recently asked my advice about how to put aside money for their new grandson, money he could use in his retirement. They didn’t have much money, but they wanted to get an early start.

I suggested a variation of an old formula that calls for setting aside $1 a day starting when you’re born. Babies can’t do this for themselves, but grandparents can. I told them that if they put aside $1 a day until their grandson’s 18th birthday, in theory, that money could grow to $1.5 million by the time he reached 65.

They could save $365 during their grandson’s first year, then add the same amount on every birthday until he reached 18.  Their total investment: $6,935.

It’s not easy to invest $365 efficiently, but exchange-traded funds (ETFs) don’t have minimums. If they could earn 10 percent, they could turn this money into more than $16,000 by their grandson’s 18th birthday.

Even during the relatively unfavorable first decade of the 21st century, ETFs that invested in small-cap stocks, real estate investment trusts and emerging markets all produced annualized returns higher than 10 percent.

The best tool available today for producing tax-free long-term returns is the Roth IRA. Any child with earned income can contribute to an IRA at any age, and I told this couple that by the time their grandson is 18 he will presumably be able to earn at least a few thousand dollars a year. The sooner this starts, the more opportunity the money has to grow without taxation.

I suggested that they offer to match whatever he earns, up to $5,000 a year, and put that amount into his Roth IRA until their $16,000 savings was all invested. (Of course there’s no law against further savings, too.)

It’s obviously impossible to predict investment returns far into the future, but I don’t think it’s out of the question that this couple’s out-of-pocket savings, just under $7,000, could grow to $1.5 million or more by the time their grandson is 65.

If he began taking out 5 percent of that money every year, he would have $75,000 – tax free – to presumably last the rest of his life. Even with its diminished purchasing power because of inflation, that’s a very impressive gift from his grandparents.

The biggest potential threat to the long-term success of this plan is the fact that the grandson can cash out the account at any time. Unless they create a trust or some other structure for ownership of the money, his grandparents can’t prevent that.

Somehow the grandparents have to motivate their grandson to keep the dream alive. One way is to have a series of conversations with the grandson, perhaps starting when he’s 20 or so. Whatever happens with the IRA, this is an excellent opportunity for building a relationship.

A conversation could go something like this:

“Your grandmother and I were young once and dreamed that one day we would be able to travel and play golf whenever we wanted, to live well and give money to our family and our favorite charities.

“But that dream didn’t quite come true for us because we didn’t figure out investing until we were older. We want you to benefit from what we’ve learned, and we want you to get an early start at creating your own dream for when you’re older.

“What would make us the happiest is to know that this money will be there for you when you’re 65 so you can do what you want. And every time you take a trip or do something special, we hope you’ll remember the dream and the love we have for you.”

Doing something very special for a grandchild doesn’t require a lot of money. But it takes planning, patience, and follow-through – three things that are necessary for success in any long-term investment. I hope they are successful with this.

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