If you've followed this blog for more than a few days, you're probably aware that Bob has written extensively about the merits of long term investing and the Rule of 72. (If you need either proof or a refresher, type 'Rule of 72' in the search box at the bottom of this page).
"...A smart buyer who purchases a blue chip stock today which is priced at $100 and pays a $3 annualized cash dividend will likely see the share price grow to ~$1,600 and the cash dividend yield $50 after 40 years, assuming that its average annual earnings grow at 7% compounded annually. "
The advice and example from above were still fresh in my mind when I came across a Dear Abby style financial advice column on Bankrate.com. Here are two separate but similar questions that were asked of Dr. Don Taylor, Ph.D., CFA, CFP, CASL:The first letter...
Dear Dr. Don,
I am a grandmother of four and want to start a life savings for my grandchildren. Their ages range from 2 to 8. Should I get savings bonds or certificates of deposit?
-- Nanna Notes
and the second one...
Dear Dr. Don, I have four grandchildren whose ages are between 2 and 4. We spend $150 on them for birthdays and Christmas. Wouldn't it be wise to purchase a certificate of deposit for them so that, when they turn 16 or 18, they will have some money for a car or college?
-- Grandma Gaye
Now, here's what our man of financial letters had to offer Nana and Grandma in the way of advice:
Dear Nanna and Grandma,
We live in an era of remarkably low rates. That can make choosing even more challenging than during other periods in our history. Choosing between EE and I.
To Nanna's question, At today's rates, I'll take the savings bonds. I only recommend the Series EE savings bonds when the bond owner plans to hold the bonds for a full 20 years. That's because a Series EE savings bond is required by law to double in value over that period. That works out to be a yield of about 3.53 percent. If you own the bond for less than 20 years, however, you get the rate posted when you bought the bond. As of this writing, the annual interest rate for EE Bonds issued between May 1, 2015, and October 31, 2015, is 0.3 percent. If you think your grandkids will want to cash out their bonds before the 20-year mark, then you may want to consider a Series I savings bond. Series I savings bonds pay a fixed rate plus a variable rate. It's the variable rate that's tied to inflation. The fixed rate stays the same over the 30-year life of the bond. The fixed rate is currently zero percent. Some other things to think about You have a few more things to consider before getting savings bonds. Do you think your grandkids will need that money for college? If so, you should know that savings bonds that are listed in the children's names (and not the parent's names) aren't eligible for the education tax exclusion when cashed in for qualified higher education expenses. Also, whoever owns the bond will need to decide whether to file annually for the interest earnings on his or her tax return, or to defer them until the bonds are either redeemed or matured. I'm assuming you won't bump up against the annual gift tax exclusion of $14,000 per child. The annual purchase limit for savings bonds is $10,000, per year, per Social Security number for Series EE and $10,000 per year for Series I in electronic form. You can buy up to an additional $5,000 in paper Series I savings bonds with your IRS tax refund. Talk to the parents about their savings goals for the children if you're planning on substantial gifts.
For Grandma Gaye's situation, what teenager couldn't use a little mad money? My advice to Nanna would work for you as well. With today's CD rates being so low, it's hard to argue for them as a long-term investment. Savings bonds aren't offering a much higher yield, but that's what I'd recommend if you want to be conservative. I'd argue that you should split your gifting between the practical (investments) and the impractical (toys).
Now here's what I'd tell the two grandmothers after they had a chance to read Dr. Don's response:
Dear Nana Notes and Grandma Gaye,
The good Dr. Don never mentioned stocks as an option for either of you, but given your (grandkids') time horizons, it's the only one that makes sense. If you take $300 and invest it in stocks annually for the next 20 years you will have contributed $6,000. Over that time though, the money will have grown to around $13,000, assuming stocks return their historical average of 7%. Investing in bonds at .3% for the same period of time will yield around $6,200.
Got it? Good, now if you don't mind, please have Dr. Don visit this blog http://augustametros.blogspot.com/ and type in 'Rule of 72' in the search box at the bottom of the page.