How to Invest in Index Funds for a Child
A stock index is a group of stocks selected based on set criteria. For example, the S&P 500 index consists of the largest 500 companies in the United States, as determined by Standard & Poor's. There are multiple indexes with a variety of criteria. Indexes are normally used as a benchmark for portfolio performance. An index mutual fund is not invested directly in the stock market but is based on changes in the prices of the stocks in the index.
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Instructions
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Set the objective for the investment. Are you teaching your child about investing? Is it for college? Will it be used before the child turns 21? Will the money be given to the child if he or she doesn't attend college? Do you want to maintain control over the funds? The objective for the fund will determine the how long you expect to hold the fund and the type of account the fund will be held in. Some college funds restrict investment selections.
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Open an account. Index funds can be purchased online through brokers such as Fidelity or through traditional brokers such as Morgan Stanley. Based on the objective, either start a college fund or a custodial account. Investment accounts for minors must have an adult custodian. You will need your child's birth date and Social Security number to open the account.
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Select the appropriate index fund using a stock screener. Kids can invest for a long period of time, so they have time to make back short-term losses. They also have the advantage of compounding longer than adults. Regardless of the time horizon for the investment, always diversify by selecting more than one category of investment. Online tools such as Morningstar.com can help narrow the available funds based on the investing objective. Select funds based on broad indexes that are not industry specific. This will allow you to instantly diversify. More aggressive indexes appropriate for children include the NASDAQ composite. A more conservative index is the S&P 500.
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If you don't know which criteria to choose, select "balanced" indexed funds that actually mimic a combination of investment categories, including stocks and bonds. Balanced funds are designed to provide a complete diversified portfolio in one investment. It's an excellent way to teach kids about investing without giving much thought to asset allocation.
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Monitor the investment. The same stock screeners used to select index funds can be used to monitor their performance. Index funds don't require a lot of adjustments, because by their nature, they are not meant to be traded in and out daily.
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Tips & Warnings
Compare the expenses of various funds. High expenses limit profits earned.
Don't be consumed with selecting the perfect fund. Many different mutual fund companies offer very similar index funds.
