It's a great idea to get children interested in investing early, and buying some stocks for them is a great way to accomplish that. I'd recommend using a very long-term buy-and-hold strategy focused on high-quality, sustainable businesses. I'd forgo dividends and focus on long-term appreciation (just my personal opinion). Stocks that I'd recommend for this strategy include Amazon.com (NASDAQ:AMZN), Berkshire Hathaway (NYSE:BRK-B), CarMax (NYSE:KMX), and Markel (NYSE:MKL). All are great companies that I'd be happy to hold for a decade.
Investment strategy: really long-term holding
Children, by nature of their young age, should have an ultra-long-term investing horizon and limited access to tax-sheltered accounts. Thus, a sound strategy is to pick a few quality companies and hold them for as long as possible. All capital-gains taxes will be deferred, you won't need to monitor the account too frequently, and it sets a good example for the children. Hopefully, they'll see firsthand the power of buy-and-hold investing, and they'll never fall into the folly of trading.
I'd also recommend individual stocks, as opposed to mutual funds or ETFs. Most investment planners will say that an index fund is a more efficient choice, but it doesn't offer the same learning opportunity as individual stocks. It's a lot harder to get excited about an index fund than about an actual business. I'd suggest diversifying as much as possible while keeping trading costs below 1%-2% of the total portfolio. And, if you can regularly add small amounts over time, that's all the better.
Stock selection criteria: sustainability and reinvestment opportunities
If you're planning to hold stocks for a decade or longer, it's important to find sustainable businesses -- those that by nature of their competitive position and industry will thrive for years. You don't want to invest in a new fad or technology that might be hot now but could be gone in a few years. You want to avoid products or industries with a high level of obsolesce. Management should be capable and honest if you're going to trust them with your money for decades.
And I know this is a bit controversial, but I prefer to avoid dividend payers. For small accounts, say $1,000, it really doesn't do much good to receive a 2.5% annual dividend (or $25 per year). That cash will probably just sit in the account, as it's not large enough to justify a trading commission to reinvest. And for larger accounts, dividends can create tax hassles -- you could end up paying the "Kiddie Tax" if investment income exceeds $1,900. So instead of dividend payers, I prefer companies that have ample room to profitably reinvest cash in their own businesses to drive long-term share appreciation.
One final consideration: If you can match a good investment opportunity with the child's interests, that's all the better. Part of the reason for investing for children is to give them a real-life lesson on business, saving, investing, and the like. If shares of their favorite store help them get interested, that's worth considering. Of course, children's interests will probably change frequently as they grow older. Keep that in mind.
My favorites: Amazon.com, Berkshire Hathaway, CarMax, and Markel
Amazon.com isn't an Internet fad -- it's a well-run retailer with a solid competitive position. Its leading position and huge size make it unlikely to be displaced. And even at its current size ($70 billion in annual revenue), it still has plenty of room to grow. Retail sales in the United States exceed $4 trillion annually, but e-commerce accounts for only 6% of that figure. Over the coming decades, more and more people will do their shopping online, and Amazon.com will be the natural beneficiary. Most people agree that CEO Jeff Bezos is a genius, and his strategy is to build the value of the business for the long term. That involves reinvesting heavily in the business and new growth initiatives, which means sacrificing short-term profits for long-term value.
Berkshire Hathaway is built to last. In addition to cash, stocks, bonds, and an array of profitable insurance operations, the company owns a diversified set of operating businesses, ranging from Dairy Queen to the Burlington Northern Santa Fe railroad. As whole, those businesses, which Warren Buffett has hand-selected, have a long-history of profitability, a strong competitive position, and talented managers. The company has never paid a dividend, but Buffett has been able to reinvest profits at a high rate of return, thus increasing the value of the business. Under Buffett's watch, book value per share has grown nearly 20% annually for nearly 50 years -- doubling the growth of the stock market during that period. Of course, Buffett is 83 years old. He's still sharp, and it's fully possible that he'll still be running the business when he's 100. But eventually he'll step away, and he is truly irreplaceable. I doubt we'll ever see another business leader with his talent. But he's recruited other very capable people, bought sustainable businesses, and created a culture and organizational structure that will outlive him.
CarMax is the nation's largest used-car dealer. It has a unique model for the industry -- a large selection of late-model cars, no-haggle pricing, and friendly, helpful salespeople. This approach has caught on with customers, 93% of whom would recommend CarMax to their friends. The company is growing: Management plans to open 10 to 15 stores annually over the next few years. It has lots of room to grow. Even as the market leader, it has only 123 stores and a 3% market share in late-model used-car sales. Used-car sales don't make up a fast growth market, but CarMax is consistently taking share at the expense of other dealers. I'd expect the company to continue opening new stores and pushing out less consumer-friendly dealers for decades. The company doesn't pay a dividend, as it's wisely reinvesting most of its cash into new stores and growth.
Markel is a specialty provider of property and casualty insurance. It has an impressive track record of writing profitable insurance and growing book value per share. Over the past 10 years, it's combined ratio has averaged 96, and book value per share has increased 230%. It has a strong team of managers, including Vice Chairman Steve Markel, a member of the founding family, and Chief Investment Officer Tom Gayner, a widely admired investor. The company is following the Berkshire Hathaway blueprint -- using insurance profits and float to acquire public and private businesses. The company doesn't pay a dividend, as it uses profits to reinvest in its business, generally at high rates of return.
Foolish bottom line
Investing is a lifelong journey, and the earlier you start, the better. If you can get a child interested and active in investing, however you choose to do it, that's a success. This is my preferred approach, but not necessarily the only way to teach kids about saving and investing.