Members of Pat McKeough’s Inner Circle sometimes ask us how to find good investments for young children. If children are under the age of 18, they cannot yet invest as adults. However, there are a couple of savings and investment options available:

1. You (or the child) can open a bank account in the child’s name: Interest paid on small balances may range from zero to, say, 0.50% annually, paid monthly. All of the major banks have special bank accounts for children, usually without service fees on basic transactions. However, once the child has accumulated $500, he or she could move the money into an interest-paying guaranteed investment certificate (GIC).
2. Informal in-trust account: If you want to build up an investment portfolio for a child, then an informal in-trust account is a low-cost and flexible option. (Investments or investment accounts in the name of a child must be set up in trust because minors are not allowed to enter into binding financial contracts.) An adult must be responsible for providing the investment instructions and signing the contract on the child’s behalf.

   An informal in-trust account has a donor (or “settlor”) who contributes funds to the trust. The trustee is the person in charge of the account, and is responsible for managing the funds for the child (the “beneficiary”). The settlor should not act as the trustee. The settlor’s spouse can be a trustee, however. The money belongs to the child, but only the trustee can make withdrawals if the child is under the age of 18. Once the child reaches 18, the money is theirs to do with as they wish.

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Focus on capital gains to find good investments for a child’s in-trust account

In an in-trust account, interest and dividend income is attributed to the contributor until the child turns 18, unless the contributor is not related to the child. However, all realized capital gains are directly attributable to the child. So when looking for good investments for a child’s in-trust account, it’s best to downplay investments that mainly provide interest or dividends, and instead hold stocks or mutual funds that will earn capital gains.

Secondary income, or income earned on income from investments in the trust, will be taxed in the hands of the child. All income earned on Canada Child Tax Benefit payments put into the account is taxed in the hands of the child, without attribution to the contributor.

Why exchange traded funds (ETFs) can be good investments for a child’s portfolio

Exchange-traded funds are good investments to start with when you begin to contribute to an in-trust account. If you start out in exchange-traded funds, we recommend putting two-thirds of your contributions into a Canadian ETF and the remaining third into a U.S. ETF.

A Canadian ETF worth considering is the iShares Cdn Large Cap 60 Index Fund (Toronto symbol XIU), which we cover in our Canadian Wealth Advisor newsletter. The fund’s units are made up of stocks that represent the S&P/TSX 60 Index, which consists of the 60 largest, most heavily traded stocks on the exchange. Most of the stocks in the index are high-quality companies.

The units trade on the Toronto exchange, just like stocks. Prices are quoted in newspaper stock tables and online. You’ll have to pay brokerage commissions to buy and sell them. However, the fund’s management expense ratio (MER) is just 0.17% of its assets.

Look to discount brokers if you plan to buy stocks in smaller lots

Of course, there’s nothing wrong with buying individual stocks with smaller sums, say under $12,000. You just have to accept a bigger proportional commission expense when you get started. To further cut your commission costs, consider buying the shares through a discount broker, rather than a full-service broker. That’s because discounters generally charge much lower minimum commissions.

If you have investment-related questions, or if you’d like to ask me about stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.