With recession looming this holiday season, we're all tightening our belts. The Internet is full of blogs offering tips on how to economize on gifts: re-gifting, for instance, or recycling glossy magazines as gift wrap.
At the same time, many parents and grandparents are looking for ways to give their children something a bit more practical and enduring than the latest battery-operated toy. Strange as it may sound, the answer might lie, not in the aisles of Toys R Us, but in the stock market.
The stock market, you ask? Isn't that the thing that plunged, leaving the economy in tatters? Well, yes. If you want a short-term return on your money, stocks are not such a good option right now. But for anyone who can afford to wait — and that includes the savvy four-year-old investor — this is a great time to receive the gift of equity.
As behavioral economist Xavier Gabaix, of New York University's Stern School of Business, says: "It's a really good idea to buy stocks now for someone like a kid who has a long horizon."
Gabaix believes more traditional cash or cash-equivalent gifts like CDs are "too boring." In this he echoes the views of financial wizard Warren Buffett, who argued in a recent New York Times op-ed that cash equivalents pay low returns and, in an economy that's likely to become inflationary in coming years, are more or less certain to depreciate in value.
Gabaix cites Buffett's simple rule to success on the stock market: "Be fearful when others are greedy and be greedy when others are fearful." In other words, when stocks are dipping in price it makes sense to scoop them up. While no one can predict how your investments will fare in the short term, Buffett, along with many economists, predicts that in five, 10 or 20 years, major companies will be setting new profit records.
There is another upside to giving children stocks: it's a great opportunity to introduce them to the concept of investing, and to teach them about long-term thinking. "Parents ought to explain to kids that what matters is where stocks are when the kids turn 18, say, but not the day-to-day fluctuations," says Gabaix. "Learning to keep the long view is a great skill."
How do you go about buying, especially if you have never dabbled on the stock market before? Nowadays there are websites such as Zecco.com, designed to let you buy and trade stocks with low commission fees, and OneShare.com, which allows you to buy an actual paper stock and frame it for a child to hang on a bedroom wall.
However, David Weil, Professor of Economics at Brown University, argues that while the idea of buying an individual paper stock is nice in theory, it can prove inconvenient in reality. "The child will almost certainly lose it somewhere along the way," he says, "and if he or she does try to cash it in someday, to cash in one share of stock is time consuming."
A better idea, Weil believes, is to buy a child shares in a mutual fund. "These funds hold diversified portfolios, which is a far better way to go than trying to pick individual stocks. Also, with a mutual fund you can put in an even amount of money — say, $100 — rather than buying a fixed number of shares."
Weil recommends that if you're planning to give a substantial sum, you should talk to an accountant about the tax consequences of different modes of giving. "In addition," he says, "you'll want to think about who controls the money — the parent or the kid — which is relevant if the child wants to access it during high school, say, to pay for partying."
If you're likely to be involved in the child's life far into the future, Weil believes the best way to invest is to put money into a 529 plan. "The biggest advantage of these plans," he says, "is that once money is put into them, it is never taxed again. Since it may be 15 or 20 years until the money is withdrawn, the advantage of tax-free compounding could be enormous."
If you live in New York State, 529 plans are especially appealing, as, according to the website www.finaid.org, New York State has among the best 529 plans in the country in terms of quality and administration costs. If you invest in one of these plans, you get a tax deduction for the amount of your gift — up to $5,000 a year — from your state taxes.
If you want your seasonal gift to offer a teachable moment on top of everything, you could consider one of the ethical investment funds. Pax World Mutual Funds (www.paxworld.com) offers "sustainable investing ... that helps us identify more forward-thinking, better-managed companies." Domini (www.domini.com) engages with companies on global warming, sweatshop labor, and product safety. After all, 'tis the season to be socially responsible.