Consider Holiday Gifts to Children That May Offer Many Happy Returns

There are only 19 shopping days till Christmas. Do you know what you’re getting your kids this year?

Every year for Christmas, I get my nephews toys. I do this not because they ask for them, but because I’m afraid of being labeled the “clothes uncle” or the “book uncle” or the “boring-gift uncle.”

Last year it was computer games. The year before that, a set of walkie-talkies. Did they really need walkie-talkies? Of course not. They live in a small Manhattan apartment where they can hear one another just fine, without the aid of an electronic device. And to tell you the truth, I’m not even sure if they wanted that gift.

Which brings me to my point. This year, I’m trying something different. I’m going to buy the two boys--ages 8 and 6--shares of a mutual fund.

Financial planners have always recommended financial gifts for children. In years past, parents and grandparents gave kids U.S. savings bonds, to teach them the importance of saving and investing--and to put something aside for college.

But today, funds are a better way to go, argues Minnesota financial planner Robert Steffen. “The opportunity for higher returns is the main reason,” he said. Whereas a U.S. savings bond currently yields under 5% a year, the typical domestic stock fund has gained nearly 13% a year, on average, for the last 15 years, according to fund tracker Morningstar Inc.

And “if you want to educate kids, I’m not sure savings bonds are a useful vehicle,” says Florida financial planner Harold Evensky. Indeed, in a culture fascinated by the stock market and brand names, what better tool is there to teach about how the markets work than a mutual fund that owns names such as McDonald’s or Disney or Toys R Us?

And here’s the coolest lesson of all: The $100 or so I spent to get the kids computer games last year will be worth nothing in 25 years--when PC technology advances far beyond CD-ROMs. But a $100 gift in the form of mutual fund shares would be worth, based on that 13% annual rate of return, more than $2,000.

The good news is that many fund companies will allow you to set up an account in a child’s name for less than $1,000.

If you buy the fund in the child’s name, you’ll need to set up a UGMA (Uniform Gifts to Minors Act) or a UTMA (Uniform Transfers to Minors Act) account. This is because minors cannot enter into an investment contract. (I’ll get to the pros and cons of buying a fund in a child’s name in a moment.)

You can put money into any one of the Janus funds through a UGMA or UTMA account for as little as $500. The Strong and Invesco families of funds allow investments in a child’s name for just $250. And the Franklin Templeton family is rolling out a gift certificate program in which you can invest in any one of 119 mutual funds in a child’s name for $100.

So which funds to choose?

* For infants, consider an aggressive growth or growth stock fund. Not only do these kids have the longest time horizons, which means they can take on added risk, they also have more years in which to outrun inflation.

Plus, for this age group, buying funds that invest in companies “recognizable” to kids isn’t necessary. Some suggestions: Janus Twenty, a large-growth fund that heavily weights Nasdaq 100 stocks such as Microsoft and Cisco Systems; Janus Worldwide, which invests both inside and outside the U.S; and Franklin California Growth, a mid-cap fund that invests primarily in California growth companies, which means it too has a heavy tech sector weighting.

* For elementary schoolkids, go with a large-cap fund that invest in recognizable names. The most obvious choices are the SteinRoe Young Investor and USAA First Start Growth. Both tend to invest in companies familiar to children, such as Hershey Foods, Mattel and Tootsie Roll Industries. And both send educational newsletters for kids.

* For teens, be more conservative. Chances are, these kids will need to tap some of that money for college within five years. So you’ll need to worry about preserving that money in addition to growing it. One idea is to go with a balanced fund, which invests in both stocks and bonds. High up on your list should be three excellent offerings from Invesco in increasing order of aggressiveness: Invesco Total Return, Invesco Balanced and Invesco Industrial Income.

The question that always comes up: Should the gift be made in the child’s name or in an adult’s (such as your own)?

The advantages of buying a fund in the child’s name are clear: In addition to the lower minimum initial investment thresholds, in most cases taxes will be paid based on the child’s lower rate.

However, once the child turns 18 (21 in some states), he or she will be free to use that money in any way he or she wants. And if the child eventually needs to apply for college financial aid, “any dollar in the child’s name counts more heavily against them than dollars in the parent’s name,” Steffen said.

Steffen’s recommendation: If you’re planning on a gift of, say, $100 or $500, go ahead and put it in the child’s name. That may give the child a greater sense of ownership.

For larger amounts that are earmarked for college, think about investing in your own name, or, if it’s not your child, in a parent’s name.

When the child approaches college age, you or the parent can evaluate the child’s ability to handle money. Then, once financial aid matters have been settled, the child can receive up to $10,000 a year tax-free.

If you want to buy a fund in your own name but don’t want to spend $3,000 for the initial minimum investment, go with a fund with a low initial investment requirement, such as the Muhlenkamp fund, with a $200 minimum, or the Nicholas or Nicholas II funds, with a $500 minimum.

These also have low turnover rates, meaning they rarely sell stocks in their portfolio. So if these funds--or an index fund, for that matter--are in your name, you don’t have to worry as much about the effects of being taxed at the higher adult rate.

* Do you have ideas for mutual fund and 401(k) topics for this column? Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.