Principles for Investing In your grandchildren

Start Early

Every Grandparent's first impulse is to lavish gifts on the newborn. But really, how many stuffed animals and cute outfits does one baby need? If you take some (or all) of that money and invest it instead, your grandchild will be able to experience the full benefit of compounding. Which is a gift she won't outgrow.

Start Small

A recent AARP Financial Inc. survey uncovered that typical grandparents spend about $150 per grandchild per year. That's more than enough to invest - and can show great growth over a lifetime. It's okay to start small - as long as you also start early.

Invest Strong

Many grandparents who do open accounts for grandchildren choose savings accounts. Unfortunately, these "low return" accounts grow slowly enough that they can easily be overtaken by inflation. To make the most of your gift, consider long-term, higher-growth assets such as mutual funds.

Watch The Fees

While it's important to invest in higher-growth opportunities, such as mutual funds, it's also important to not reduce the value of the investment with high fees. The average annual cost of a stock mutual fund is 1.02%, according to the 2008 Investment Company Institute (ICI) Fact Book. But you can find funds that perform well and charge .50%. Or even less. That may not sound like much of a difference, but consider that a $10,000 investment in the lower cost fund would earn an additional $3,691.27* over 20 years, given the same rate of return and reinvestment of earnings. Wow.

*Assumes 7% annual return and includes the money that would have been made if fees were revisited. Source: SEC Mutual Funds Calculator.

Keep It Simple

You don't need to day trade, sell short or find complicated investments to get good returns. Instead, choose something with diversification and rebalancing built in to ensure the best possible results with the least oversight and management.

Consider College

The ever-growing cost of college tuition is an expense that someone has to cover. Increasingly, it's the student himself in the form of student loans that can take decades to pay off. If you're thinking about opening an account for a grandchild (and we hope you are) consider a tax-deferred college savings account like the Coverdell Education Account or 529 College Savings Plan. Earnings on these accounts are usually free of federal income tax.

Remember Your Grandchildren

Naming a grandchild as a beneficiary on your retirement account or insurance policy is an easy way to pass money along without stressing your current finances. And maybe bypass some taxes, too.