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Safe savings for children

Chris Farrell Feb 9, 2010

Question: Greetings Chris. We are HUGE supporters of Marketplace Money on Sat!

Questions for you: We have 3 children with CD’s currently maturing at:

11th grader $1000 ($1041 at maturity)
8th grader $500 ($21 at maturity)
6th grader $500 ($21 at maturity)

We want an investment timeline for them that takes us to the 18 y.o. mark for each of them. What are good options for continuing short term low risk investments? We see CD rates right now which are .5 %. What low risk investment options do we have to take each of them to their 18th birthday? About 1 yr investment for our junior in high school, longer (4-7 yrs) for our other younger two children? Are CD’s the best option for this time period? Thanks for help. Mitch and Jeanne

Answer: Thanks for listening. Savers sure aren’t getting much of a return on their money. It’s one way the government bailed out the banking system. In essence, savers are making a fraction off their deposits and the banks are earning profits by investing the proceeds in higher yielding investments, especially U.S. Treasuries. (Of course, it’s more complicated than that, but not much.)

That said, it does appear that the economy is on the mend. If the recovery becomes self-sustaining you should start seeing at least slightly higher rates on savings accounts, CDs, and the like. The demand for credit grows when the economy is expanding, and that will put some upward pressure on rates. The Federal Reserve will eventually hike its benchmark interest rate, a move that will ripple throughout the fixed income market. Inflation fears will stir during the expansion, too.

Taken altogether, and assuming a double-dip recession isn’t in our future, the next move in rates will be up.

At the moment I don’t see you earning much on the money. One reason is you don’t want to take credit risk with the money. That keeps the investment in low-yielding government-backed type securities. Another factor is you’ll want to stay short-term, say, no longer than a year. That will also keep the current interest rate on the investment low. You will want to compare what you’ll get from similar investments. For example, I would look at what your children will get in a federally insured one-year CD versus a one-year Treasury bill. There is no state and local government tax levy on U.S. Treasuries. You could do the same thing with 3 month, 6 month, and other maturities.

The historic record shows that high quality short-term investments like these will protect your money against the risk of inflation because when rates start climbing you’ll reinvest the money at the higher rates relatively quickly.

The other quality investment to consider is savings bonds. You won’t want to touch them for 5 years (otherwise you give up the last three months of interest as a penalty for early redemption).

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