Turn Your Child’s Savings Bonds Into Double-Digit Investments

 

“If you would be wealthy, think of saving as well as getting.” – Benjamin Franklin

By cashing in your children’s savings bonds and investing the proceeds in equity mutual funds for the long term, you stand a good chance of helping them get 10% to 15% or more in compounded annual returns. And that creates far greater wealth than the 3% to 4% returns that savings bonds typically pay.

For instance, let’s say you received a $100 EE savings bond with an equivalent yield of 4.25%. That means the bond was bought for $50 and should mature to its $100 face value in about 17 years.

If, however, you cash it in after six months (the minimum time you have to hold a savings bond), you should receive about $50.50 for it. (You get $50.50 from the original $50 investment plus six months’ interest, minus a 3-month interest penalty.)

Now, invest that $50.50 in the stock market for 16 1/2 years. (Remember that six months will have already gone by.) For comparison’s sake, we’ll use 10.4% for the mutual fund, since that is approximately the compounded average annual return of the S&P 500 for the entire 20th century, including both bull and bear markets.

What happens? Instead of your ending up with $100 17 years after receiving the bond, it’s now worth $258. More than 2 1/2 times the value it would reach as a savings bond.

And the longer we extend this scenario, the greater the difference becomes. If you let the savings bond initially purchased for $50 compound at 4.25% for 30 years, it turns into $174. But if you cash in the bond after six months and invest the $50.50 at 10.4% for 29 1/2 years, it turns into $4,785 — more than 27 times the value!

The ability to get maximum compounding returns over long periods of time is your children’s greatest strength as young investors. Yet savings bonds don’t take advantage of this strength. And that’s why their savings should be in stocks (specifically equity mutual funds) instead.

Why equity mutual funds, in particular, for the long term? Because, even using simply average returns, no major asset class pays off like stocks in the long run. Over the last century, in fact, stocks created 1,148 times the wealth created by gold, 254 times that created by Treasury bills, 178 times that created by government bonds, and 84 times that created by blue-chip corporate bonds.

But it gets even better …

When investing for the long term, stocks not only offer higher returns but also provide the highest risk-adjusted returns.

Which equity mutual funds should you choose for long-term investing? Here’s the short answer: Buy sectors of the market that (1) are likely to always play an important role in the economy, (2) are currently out of favor with the majority of pundits and investors, and (3) are selling far below their all-time highs (by at least 50%).

There’s no question about it. Your children are naturally suited to be long-term investors who can most benefit from the higher risk-adjusted returns offered by the stock market. Help them do that even with their savings bonds and you can help increase the future value of their current savings by more than 27-fold over the next 30 years.