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Our Children's Future
To whom should we trust our children's financial well-being, and when should we start? Those are the questions, amongst others, that I set out to answer in my book "How to Make Your Child A Millionaire: The Fool's Guide." And actually, both of those questions are easy to answer. We should trust no-one but ourselves and we should start now. But where should we put our children's money?
None of the perennial favourites, from premium bonds to friendly societies, banks, and all the rest really come up trumps. And endowments, as so many people are painfully aware these days, are far from being the sure thing that they were portrayed as just a few short years ago.
Shares Are What We Want
By far the best-performing investment vehicle in living memory has been the stock market. Shares in public companies represent part-ownership of the real means of wealth creation and that, surely, is something that we want our offspring to share in fully.
If we want to see exactly how well shares have outperformed all other investments, we only need to turn to Credit Suisse First Boston's rather excellent Equity-Gilt Study. What that study entailed was examining the effect of putting money into three alternative forms of investment, Equities (shares), gilts and cash, and counting the returns that each would have generated. And to emphasise the long term nature of the stock market, the study goes all the way back to 1869. Here's what they said...
"After adjusting for inflation, we calculate that a £100 investment in an equity fund in 1869 would now be enough to buy a substantial house. The gilt or cash fund, however, might not even pay one year's council tax on the property."
How Much?
In fact, if one of your ancestors had made a single investment of £100 in the stock market in 1869 and you had inherited the proceeds, you could expect to be sitting on a cool £20 million today (so that "substantial house" is actually a bit of an understatement). Taking inflation into account, that £100 in 1869 was the equivalent of approximately £4,000 today, and converting £4,000 into £20 million in real terms isn't a bad result, is it?
Admittedly, 130 years is rather a long time to wait, and though our children do have the advantage of plenty of years ahead of them, we might be expecting just a bit too much from advances in medical science if we think they're going to be able to accumulate and spend their £20 million. So how much can they reasonably expect to earn from an average lifetime of investing in shares?
You might be surprised to hear that an investment of just £25 into a simple index tracker, continued from birth until the age of 60 will, if the stock market continues to grow at the same rate it has achieved since 1869, amount to a retirement pot of nearly £900,000 (and if the higher rate of returns achieved from 1918 to the present day is maintained, you'll be looking at more than twice that amount). Isn't it surprising that a modest amount invested every month could enable your child to retire as a millionaire? That's in today's prices, of course, but over your child's life you can surely expect that monthly £25 to increase in line with his or her earnings, with the net result being a very comfortable retirement indeed.
But Isn't It Risky?
Many would shy away from staking their childrens' future on the stock market, and might raise their hands in horror at the prospect of risking junior's precious savings in such a way. But investing in shares, providing a sensibly balanced portfolio is what you go for, is only risky in the short term. In fact, many people confuse short-term volatility with genuine long-term risk, and end up shortchanging themselves by putting their money into "safe" lemons instead of cornering their own share of the real means of production.
Over the long term, investing in shares is a low risk enterprise, and the longer you have at your disposal the lower the real risk. Children, of course, have the most time available of anyone, and so investing your children's money in the stock market is in fact less risky than investing your own (as you'll need to get your own money out sooner).
When people express horror at the "reckless" way you're investing your kid's money, you can sit back with happy confidence and know you're doing what's best for them.
A Balanced Portfolio
What shares should you buy? For a child's long term future (and particularly if you don't want to be spending hours every week poring over the financial papers and watching your share prices), a well-balanced portfolio of large solid companies has to be the best way to go. The simplest and probably the safest balanced portfolio that can be achieved is a low cost index tracking fund. Such funds rarely attract more than 1% in annual charges (with no entry or exit charges), and many can actually be had for 0.5% per year or less. Index trackers will typically allow you to contribute regular monthly amounts too, often as low as £20 per month, and so are ideal for regular investments for children.
The two most popular indexes to track in the UK are the FTSE 100 and the FTSE All-Share, and there are plenty of suppliers to choose from. Which you choose probably won't make much difference in the long term, as the FTSE 100 accounts for around 80% of the value of the FTSE All-Share anyway.
Self Selection
Going beyond a tracker is not too difficult if that's what you want, and many people do exactly that, often combining a regular monthly index tracker investment with occasional hand picked shares.
To help minimise the effect of brokers' commissions, it makes a lot of sense to open a savings account for your child to use for accumulating short term money. Shop around though, and you'll be surprised at the difference in interest rates you will find. Currently, some building societies are offering significantly more for children's accounts than the traditional high street banks.
If you save all those cash presents from birthdays and Christmas, and any extra sums you can afford from time to time, until you have a sufficient sum (say £1,000) to invest, you can alleviate the effect of brokers' minimum charges. It's much better, for example, to pay a minimum £10 commission when investing £1,000 than to pay the same minimum to invest just £250. A small percentage difference in charges can add up to an awful lot of money long term.
Once you've got a sufficient sum to invest, buying shares in a large well-respected blue-chip company is the way many parents prefer to go, because such companies are the most likely to provide safe long term investments. And if you buy shares in a different FTSE 100 company every time, spreading your money across different sectors, until you have a portfolio of 10 to 15 companies, you'll be placing your children's financial future in the hands of some of the pillars of our economy.
What About The Red Tape?
You might think that investing in the stock market in the names of your children would be complicated. After all, the words "investing regulations" and "transparency" are rarely mentioned in the same sentence. But actually, it's pretty straightforward, thanks to a very simple investment vehicle known as a "bare trust".
Any savings account or investment account (be it a building society account, or a stock broker account, or whatever) can be designated a bare trust with a nominated child as the beneficiary. All you need to do is open the account in your name, and append the child's initials in parentheses, so Marge Simpson might open a bare trust for little Lisa by simply designating the account "Marge Simpson (LS)". It really is as simple as that (and some savings institutions make it even easier, by including a box on the application form for naming the child beneficiary).
Having done that, the named adult then has control of the account and the designated child is the beneficiary, with the proceeds having to be handed over when the child reaches the age of 18. You can set up a bare trust for any children you choose, not just your own, and each child has a tax-free income and capital gains allowance of his or her own to use up.
A bare trust can be registered with the Inland Revenue for a nominal sum if you really want (your local tax office should be able to send you the appropriate form), but there is no need to do so, and no real advantage.
Education
A worry that is often expressed by parents goes something like "But when they grow up and get their grubby little paws on the money, what's to stop them cashing it in and spending it all on drunkenness and debauchery?" My answer to that is "Education." Education in financial matters has been sadly lacking in our schools for generations (though it is to the government's credit that the subject is finally being seen as worthy of study), but it can and should be taught to all children. If you make sure your own children are educated in need for sound financial management and expose them to the wonders of long term investing early on, you will have done them a great service.
Parents' approaches should be two-fold then; start saving and investing for the kids as early as possible, and ensure that they're taught properly in order to take over for themselves and ensure their own long term comfort.
Where Next?