You can make your child rich with the minimum of effort.
My best investment of 2009 was a baby girl called Alice, born in January. Her weight grew by 300% in the year; her height by 60%. Beat that, Buffett!
Last week, she grinned and gurgled her way through her first birthday party. She already has a good grasp of inflationary theory, as long we're talking about shiny pink helium balloons. And, although she doesn't yet know it, she's already on her way to being a multi-millionaire.
Little Rich Girl
How did I do that? Easy. Umbilical cord scarcely cut, I summoned the holy Foolish trinity of compound interest, regular saving and stock market patience.
The trick is this: I set Alice up with a regular premium pension scheme and arranged to pay in her Child Benefit each month. From the hundreds of funds available I selected a simple global equity index tracker.
That's it. Hardly quantum mechanics, is it?
But, as Einstein himself is supposed to have said, "compound interest is the most powerful force in nature". And when you're so young that 'money' is something you find on the floor and stick in your mouth, compound interest has the power to make you seriously, massively, life-changingly rich.
The secret
Not many people know that everybody in the UK can claim income tax relief on up to £2,880 of net annual pension contributions. This even includes new-born babies with zero income. So, every £80 a month that hits her pension becomes, as if by magic, a £100 contribution after basic rate tax relief.
Let's make some assumptions: I continue these monthly payments for as long she qualifies for Child Benefit (currently age 18); investment returns will be 9% a year; and after 18, she makes no further pension contributions of any kind. She just watches her pot grow until, in the year 2074, she finally retires.
At 65 her retirement fund would be worth £3,079,600.
You did read that correctly: over three million quid, just for recycling her Child Benefit every month from birth to 18. It's not that I'm a brilliant investor; it's just the ultimate long-term plan.
Horrible market crash next year? Alice doesn't even need to glance up from her shiny cardboard book about farm animals. It won't matter to her one bit.
Inflation will take its toll of course and reduce the purchasing power of her £3m come 2074. But, even adjusting for this, it's going to be an extremely large sum of money.
Why o why?
Why have I done this? I think it's one of the best presents I can give her. For the whole of Alice's working life she will know that her retirement is already looking pretty rosy. She won't need to struggle to fund pension contributions in her twenties and thirties. She won't be left playing 'retirement catch-up' in her forties and fifties, when many people suddenly wake up to their imminent dependence on the paltry state pension.
But there's also a discipline to my plan: she won't be able to spend the pension pot until she's mature enough to appreciate it. I shudder to think what I would have done with £50,000 at age 23. A pension is untouchable; it's a secure nest egg in every sense.
Alice doesn't have wealthy parents. She probably won't inherit several millions when we die. But she does have Foolish parents. We know that giving up £80 a month today will be worth the world to her when we're long gone. It's not much of a sacrifice, either. We don't have satellite TV and we choose not to smoke. That's at least £80 a month extra in the bank.
Child Trust Funds
Of course, we want her to have a good career and the chance to make her own fortune. University will probably beckon. This is where her Child Trust Fund (CTF) will come in handy.
Since 2002 the taxpayer has given a £250 voucher to all British babies. Families on a low income get £500. Parents can use the voucher to open a CTF account for their child from hundreds of possible providers. There are stakeholder accounts, offering a limited number of low-cost funds, and non-stakeholder accounts with wider choices, but higher costs.
A second voucher will appear at the child's seventh birthday. The CTF account can receive extra contributions, from any source, of up to £1,200 per year, and there is never any tax to pay on growth. So a 'fully funded' CTF, assuming two £250 vouchers and 9% investment growth, could be worth £55,600 by Alice's 18th birthday. I invest her CTF in an index tracker.
The Future
My aim is to raise a young woman who can handle money responsibly. The CTF always belongs to the child; she will be free to spend it all as she chooses at 18. Will she use it sensibly to fund her three years at Cambridge? Or will she buy a classic sports car and go on a long holiday with a failed guitarist called 'Fingers'?
We shall see… but at least I know her pension pot will be safe.
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