Sure, your children may want the latest iPad, gaming system, or headphones for Christmas, but will they still be using it next year? How about in five years? Ten years?
If you give your child a gift that promotes financial responsibility and smart habits, it will literally last the rest of his or her life. And with the most powerful investing tool in the world -- time -- working in your child's favor, you may be surprised at just how far the cost of an iPad can take your child.
Buy some "fun" stocks
If you choose wisely, buying a few shares of stock for your child can go a long way toward getting him or her interested in investing at a very early age.
As a basic guideline when choosing stocks for kids, keep in mind that kids like to invest in what they can see. Every kid knows Disney and its products, as well as Apple and Facebook. It helps kids to get a real perspective of what the stock market is about if they can see the company they own a piece of in action. Plus, anyone who doesn't think investing can be fun for kids never saw a child going around to friends and telling them he or she owns Disney World.
A Roth IRA is the best way to capitalize on long periods of time
Did your son or daughter recently enter the working world, even on a very part-time basis? An IRA could make a great gift this holiday season.
When Americans want to save for retirement, there are two basic types of tax-advantaged accounts to choose from: traditional and Roth IRAs. Now, for many people there are positives and negatives to both accounts. However, when it comes to your kids, it's a no-brainer.
Basically, a traditional IRA lets people take their tax break now by deducting contributions from current taxable income, while a Roth IRA doesn't allow for a present-day tax deduction, but qualifying withdrawals made from the account will be tax-free.
In order to be eligible to contribute to a Roth IRA, your child needs to have some income. Specifically, the child's income (which can be from a paper route, part-time job, or wherever) must be equal or greater to the amount of your contribution. Once that is established, you are in the position to open an IRA account for him or her. Since kids generally don't have much income to use a current tax deduction against, the benefits of a traditional IRA are very limited. However, by opening a Roth IRA, you're opening the door to decades of tax-free compounding, which is the most powerful force in the investing world. I'll illustrate this concept with a basic example.
Let's say you open a Roth IRA for your child with $1,000 and invest in an S&P 500 index fund, which has averaged about 9.4% in annual total returns over the past 20 years. If your child is 15 years old, at this rate of return, the account could be worth more than $36,000 by the time he or she turns 55, even with no further contributions.
By the time your child is 65 and ready to retire, your original $1,000 gift could swell to nearly $90,000. Imagine how this could add up if you do the same thing every year while your child is young.
If you give an allowance, consider giving more money, but less frequently
If you give your kids an allowance, it can be an excellent way for them to learn how much things cost and how to save for what they really want. However, by giving them more money less frequently, it helps them learn how to effectively budget their money over long periods of time as well.
As an example, if you give your child $20 per week, try giving $100 per month and seeing how he or she does with it.
You could also offer an incentive for good financial behavior. For instance, you could offer to match any money left over at the end of the month as a contribution to a savings account.
It may seem silly at first to give relatively large sums of money to teenagers. The first few times you do it, they might make you regret it. But if you stick to the plan and make them wait until next month to receive any more, it can go a long way toward building solid budgeting skills.
Worth so much more than buying them the latest gadgets
By all means, if you still want to get your kids an iPad or whatever else is on their holiday wish list, go for it.
However, these are some ideas for gifts that will literally keep on giving throughout your child's lifetime. Sure, your kids would rather have a new Xbox now, but the same amount of money could turn into thousands of dollars down the road. Better yet, it could help them build solid saving and investing habits that will serve them for the rest of their lives.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple, Facebook, and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.