FOOL SCHOOL
Investing For Children (Part 1)

September 9, 2002

By Nigel Roberts (NigelTMF)

We all want to provide for our children, and there are many things that we can do that will help them all their lives. One is to teach them about the value of money and the importance of saving. Teach your children to save; teach them to be Foolish.

Be a good role model

Some time ago, I came across the following quotation: "Be a good role model. Children are more likely to be good savers if they see that their parents save regularly and find saving money to be worthwhile." It really does sound simple, doesn't it? I do think that teaching our children to save and save regularly is one of the most important things we do for them. Certainly the best way to teach them is through setting a good example -- my wife and I both learned the importance of saving from our parents, and we intend to pass that lesson on to our children.

The Fool seems to be awash with proud parents showing off photographs of their bouncing babies -- I admit that I am one of those very proud dads who carry around photos of their children in his wallet, eager to pull them out at the first opportunity -- and we have had many messages posted to the Investing for Children discussion board asking questions similar to this one: "I have some money that I would like to invest Foolishly for my children -- how do I go about it?"

Why It's Important

One of the best ongoing presents that you could give to your children is to invest some money for them that can be left undisturbed until they are adults. This will enable them to benefit from the miracle of compound returns. Imagine what would have happened if, when I was born, my parents had the foresight (and financial ability) to invest some money into the stock market on my behalf.

The long-term return on investing in the UK stock market has been around 11% per annum since 1918 (with around 4% of this due to inflation). So imagine if my parents had been able to squirrel away £100 into a (theoretical at the time) tracker fund for me when I was born. Suppose they had then added £100 each and every year until I was 18, and the historical return had been achieved; it would then have been worth about £4,000. If they had then handed the fund over to me, and I had simply left it alone until I reached the grand old age of 50, a total outlay of £1,800 would be worth about £114,000 (based on 11% growth per annum). If I did not touch this money until I retired at the age of 65, then through the magic of compound interest this could be worth about £0.5 million -- on a total outlay of £1,800!

Now, OK, we recognise that this scenario is impossible in real life, as there will be issues of tax, both income and capital gains, to be contended with as well as the damage that would be caused to the spending power of the final fund by the ravages of inflation and charges. And I am sure that well before I reached 65 I would have found many compelling ways of spending the money. But that should not detract from the wonderful gift that such an investment would have been; it does demonstrate the power of compounding over the long term.

Invest your kids' savings in the stock market? Surely not!

My wife and I are investing money for our children. I have told many of our friends that we are investing our children's savings in the stock market, and it is amazing how often we get looks of amazement and even horror. People express the view that we are taking an unnecessary risk, and that we should simply leave the money invested in a bank savings account. But look at this table, which shows what would happen to an initial contribution of £100 a year, invested at various growth rates.

Year     4%      8%      12%     
1      £100    £100     £100     
5      £122    £147     £176     
10     £148    £216     £311    
18     £203    £400     £769   
21     £228    £503   £1,080   

The rate of 4% represents a typical interest-bearing account for children, while 8% represents what you might expect from a tracker fund, once the current low rate of inflation and charges are taken into account. The higher rate is for the ambitious stock pickers amongst you! Over time, the market has historically been the best place to put your money. The so-called "safest" investment vehicle -- putting your money in an interest-bearing bank account -- is in one sense the most guaranteed of them all to be a losing proposition, unless of course you simply stuff your savings under your mattress and watching it eaten away either by mice or by the sharp teeth of gnawing inflation.

Why is this? Because if you're getting, say, a guaranteed 4% a year, then you're missing out on the much greater growth that the stock market can give you. It's true that you're protected from losing your initial investment if you take the conservative bank account route -- but you're also "protected" from any major long-term investment returns.

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> Part 2 | Part 3