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Ask Money

Long-term savings for daughters

Chris Farrell Jun 23, 2010

Question: My dad has generously given each of our two young daughters (currently 5 and 3) $1000. His intent is that these funds should be invested for the long-term – as in retirement! Both girls have healthy 529 accounts already, and we are eager to honor my dad’s wishes for this gift. As the money was not earned income, I understand that IRAs are not an option. Is that true? If so, what’s our best bet? An index 500? Thanks! Liz, Centreville, VA

Answer: That is a generous gift. And your daughters already have well-funded college savings plans. Yes, an IRA has to be funded with earnings.

I like your idea of putting the money into an S&P 500 equity index fund or the broader based Wilshire 5000 Total Market Index (it essentially captures the universe of publically traded U.S. stocks.) The money in the taxable account will compound over time, and taxes will be low over the years. Basically, your daughters will own a stake in the U.S. economy.

I’ve always liked this observation of Warren Buffett, the Sage of Omaha. Buffett is a dedicated, methodical stock-picker if there ever was one. Yet for most individuals he’s a proponent of index funds. “By periodically investing in an index fund,” Buffet wrote in his 1993 annual letter to Berkshire Hathaway shareholders, “the know-nothing investor can actually out-perform most investment professionals.” Investing the money in equity index funds may not make your daughters the Sages of Centreville, but it’s a strategy that has worked well for many people.

A more conservative alternative is putting the money into savings bonds, say, the I-bond. It’s the inflation-protected savings bond. The money would hold its value over the 30 year life of the security, plus earn a bit of interest along the way. You could also do a mix, say, 70% to 80% in a stock index fund and 20% to 30% in I-bonds? Diversification is a good financial habit.

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