If you have never given a child shares in a publicly traded company as a holiday present, that's probably just as well. Presents are supposed to be fun. Investing in equities — as remunerative over the long haul as they have proven to be — isn't much fun a lot of the time.
That said, the impulse to give stocks as a gift to a youngster is understandable, even noble. We want children to develop critical life skills around money as early as possible. The more they learn about saving and investing—to say nothing of compound interest, dividends, the economic cycle—the better. We know how important this stuff is going to be for them in ways they can't yet imagine.
Stocks even have a singular appealing quality as a gift. They're dynamic. A child can follow a company and its stock. Hopefully, the stock will appreciate in value. Perhaps you and your grandchild will bond as you study corporate developments and stock charts together. A gift that allows the two of you to spend time together, while learning something and maybe even making a little money, too? Sounds lovely.
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Just be aware that if your only goal with this gift is to beat the market, you are almost certain to be sorely disappointed. It's nigh impossible to beat the market every year, year after year after year. Over the past two decades, more than 92% of all U.S. actively managed mutual funds underperformed the S&P Composite 1500, according to Standard & Poor's SPIVA Scorecard. Nearly 95% of all U.S. large-cap funds trailed the S&P 500 over the same time period.
Consider indexing vs buying stocks
The vast majority of full-time professional investors can't beat the market, so why should you?
The simple fact is that most pros can't beat the market because most stocks can't beat the market.Between 1990 and 2020, more than 55% of all U.S. stocks underperformed risk-free one-month U.S. Treasury bills, according to Hendrik Bessembinder, a finance professor at Arizona State University. These stocks didn't just fail to beat the market, they failed to beat cash. Even more damning, the professor found that the entirety of the $76 trillion in net global stock market wealth created between 1990 and 2020 was generated solely by the top-performing 2.4% of stocks.
Finding winning stocks is like finding needles in haystacks. That's why Vanguard founder and indexing evangelist Jack Bogle always advised clients to "buy the haystack."
So if part of the purpose of giving stocks as a gift is to teach your grandkids about investing, you should probably start by discussing the advantages of indexing. You might also want to let them know about the miracle of compounding. Between the two, passive investors have done quite well for themselves over the years.
If you can achieve an annualized return — also known as a compound annual growth rate — of 7.18%, your initial investment will double every 10 years. Happily for all of us, the S&P 500 has generated an annualized return of at least 7.1% over the past 10, 15, 20 and 30 years — and that's after inflation. The market has basically been doubling our money or better in real terms for decades.
You could explain these facts to your grandchildren as you give them some S&P 500 ETFs, such as the SPDR S&P 500 (SPY) or the Vanguard S&P 500 (VOO). An ETF is probably an even more disappointing present for a kid than stock (or underwear), so it's bound to make an impression. The important part is that the child learns that indexing is generally the best way to go for most retail investors.
The best stocks to buy your grandchildren
If the point of this holiday gift isn't to teach your grandchild about the wonders of indexing, then here are some general guidelines for picking equities.
If you give shares in some company to your grandkids as a gift, they probably don't care about dividend yields or price/earnings multiples or trailing-12-months levered free cash flow. If you must buy individual stocks as a gift, be sure to invest in high-quality companies your grandchild recognizes and maybe cares about.
High-quality blue chip stocks with fortress-like balance sheets and a decent chance of beating the market over the next, say, five to 10 years, are easy enough to screen for. Have a look at what industry analysts believe are buy-rated blue chips with interesting businesses.
Apple (AAPL), Microsoft (MSFT) and Walt Disney (DIS) are all buy-rated components of the Dow Jones Industrial Average—and they can be fun (or at least fun-ish) to follow. Nike (NKE) is another buy-rated Dow stock that likely holds relevance for your grandkid. Wall Street also happens to be bullish on Dow stock McDonald's (MCD) these days. Perhaps your grandchild would like a side of fries with her shares in the Golden Arches?
If you really want to teach your grandkids about investing, start with indexing. If you want to have fun playing around with individual stocks, go ahead. Just know that you're going to have lots of ups and downs.
Bottom line: make sure the stocks you gift are somehow relevant to the person receiving them. If you want this present to hold a kid's attention longer than most gifts do, that's the only hope you've got.
Note: This item first appeared in Kiplinger Retirement Report, our popular monthly periodical that covers key concerns of affluent older Americans who are retired or preparing for retirement.Subscribe for retirement advicethat’s right on the money.
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