New Ways to Invest for Grandchildren

The market sent a message to grandparents the last few years. To ensure the success of your plan to leave the grandchildren wealth, heed this message.

A time-honored practice when setting up an account or trust for grandchildren is to buy shares in one or a few favored companies, then leave them alone. The grandchildren and their parents often are told to leave the stocks alone and hold them until the money is needed

This was fine advice for the many companies that became dominant after World War II, expanded that dominance around the globe, and enriched their shareholders for decades. Even the bear market of the 1970s merely slowed the effectiveness of this strategy.

But the changing economy of recent years should force you to reconsider.

It is very difficult for a company to maintain its dominance for decades, as in the past. Even companies that do maintain prime positions in their industries might see the growth of their industries or their pricing power disappear. Their brand names might become mere commodities.

In recent years, the world’s greatest brand-name, Coca-Cola, saw its sales growth slow rapidly. It’s ability to raise prices also disappeared in the deflation of 1998-1999. Coke’s stock price fell by half. Procter & Gamble’s stock price recently was cut in half. McDonald’s has been limping along for years as the company struggles for ways to increase earnings growth. A host of lesser companies also have been in the doldrums and left behind by the bull market.

It is possible that Microsoft, Dell, Intel, Cisco Systems, and a few others might dominate their industries and the global economy the way the big consumer brands did in the past. But technology changes so rapidly that I wouldn’t feel comfortable proposing to lock up any of these stocks for 20 years or so.

Grandparents should consider a few other options for increasing the wealth they can leave to their grandchildren.

It still is possible to increase the legacy to your grandchildren by putting quality stocks in an account for them. Just don’t count on leaving the account untouched. You or someone else should be watching the portfolio regularly. The stocks don’t need to be traded frequently. But they should be reviewed regularly for shrinking markets, reduced pricing power, or other signs that growth might slow dramatically or even stop. These days, four to five years seems a long time to hold a stock.

Another option is to invest in one or more mutual funds.

Even here you have to be careful. Fund managers change jobs regularly. Others change their styles. For a grandchild’s account, I wouldn’t try to find market-leading funds. The market leaders of a few years ago are the dogs today. I also wouldn’t use a sector fund or other narrowly invested fund for this type of account.

Instead, I would use an index fund or funds that are managed by committees with the same style or system. The accounts won’t be big market-beaters, but they will provide steady, consistent returns relative to the index. The funds should be broad-based. Don’t assume that certain types of stocks, such as large growth companies, will always dominate the market. In index funds, choose one that captures most of the market, such as Vanguard Total Market.

You also can use the newer innovation, exchanged traded funds or index shares. These are index funds that trade on the stock exchanges just like company stock. They can be bought or sold through a broker at any time during the day. They also might have lower taxable annual distributions than regular index funds, and in some cases have lower expenses. Two broad-based funds to consider are the Russell 3000 (Ticker: IWV) and the Dow Jones U.S. Total Market (Ticker: IYY).

Or you can combine several indexes that will give you broad market exposure. For example, buy the S&P 500 Index and the S&P Mid-Cap Index. But don’t buy them in equal amounts. The large cap stocks in the S&P 500 account for about 75% of the market’s value.
The indexes also can be used to add international diversification to your portfolio. You can try Vanguard Europe and Vanguard Pacific for exposure to the developed markets. The exchange-traded index shares have separate indexes for each country.

The final option is to own diversified, actively-managed mutual funds. You can use diversified funds that I recommend for the Core Portfolios, such as American Century Income & Growth and Dodge & Cox Stock. Or you can use a combination of value funds and growth stock funds. That way, the account overall will do well whether growth or value stocks are doing better at any time. If the account is large enough, add one of my small stock funds to ensure it is fully diversified.

Your grandchild might very well become a multimillionaire on a rather small investment if you pick the right few stocks to put in an account. But the odds of your picking the right stocks aren’t very high. In most cases, the grandchild would be better off if you set up a diversified, long-term portfolio instead of trying to pick the best stocks. The account will grow steadily over the years with the market if it is filled with broad-based index funds, exchange traded index shares, or consistently-managed, diversified mutual funds.