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Why investing for your child’s future matters
Put simply, you don’t want to be caught off guard when your child asks for help with a home deposit.
This is one of the most common reasons parents end up financially supporting their children. In my experience, the average amount parents “gift” to a child is around $50,000 – a significant sum, especially if you have more than one child.
Beyond a home deposit, there are many other reasons parents may choose to help their kids financially, such as covering university fees, assisting with rent when they first move out, or even helping them buy their first car.
By starting early and setting aside a small amount each month, you can build a financial safety net to support them if needed. For example, investing $50 per month into a bank account earning 4% interest would grow to $18,339 over 20 years.
However, it’s important to consider whether a bank account is the best option. If you invested the same $50 per month in a portfolio earning 10% per year, it could grow to $37,968 over the same period.
When you should start investing for your child
You should start investing as soon as possible. The earlier you start, the more flexibility you have and the less you need to contribute over time – through the magic of compound interest.
For example, if you aim to gift your child $50,000 in 20 years’ time, you would need to invest $65 per month at an average annual return of 10%. However, if you started just five years earlier – giving yourself 25 years instead of 20 – you’d only need to contribute $38 per month to reach the same goal.
This small change makes a big difference to your cash flow, showing the power of starting early and letting compounding work in your favour.
Setting financial goals for your children’s future
If you’re unsure about how you’d like to help your children in the future, it’s unlikely you’ll take the first step. And the longer you wait, the harder it becomes to achieve your goals.
If you’re unsure where to start, consider aiming to help them with $50,000 when they turn 25 and begin investing today. You can always adjust the target or the amount in the future, but the most important step is to start now.
And when the time comes, if you don’t have the full amount you wanted to give, you will at least have some – and that helps too!
Investment options for saving for your children
Savings accounts vs. your home loan
Many parents with young children also have home loans. For every dollar you put into a separate savings account for your child, you’re usually taking a dollar away from your home loan repayments. If you save in a separate bank account for your child, you’ll likely have to pay tax on the interest, which reduces your overall wealth over time. Additionally, the interest rate on your home loan is typically higher than that of a savings account, meaning you’ll end up paying more in interest on your loan than what you earn for your child. This isn’t ideal.
However, there are solutions. If you have an offset facility, you could open a new offset account and transfer the money there for your child’s future. This would save you interest on your home loan while keeping the money separate and easily identifiable for your child.
If you don’t have an offset facility, you can start tracking your contributions in a spreadsheet. Simply record how much you’re setting aside each month for your child and the current interest rate on your home loan. Once your home loan is paid off, you’ll need to remember to set aside the amount you’ve “owed” your child.
Shares and ETFs for long-term growth
Shares and exchange-traded funds (ETFs) offer higher growth potential but come with higher risk. For long-term investing, you should target a return of above 10% but be prepared for some years with significant negative returns.
This strategy can be used even if you still have a home loan, but it’s more complex. It could potentially save you some tax, though I recommend seeking professional financial advice to set it up properly.
Investment bonds
Investment bonds are a great option if you don’t have a home loan or for grandparents looking to set aside money for their grandchildren. An investment bond works similarly to superannuation, with a different tax structure, internal tax, and the option to pass directly to a beneficiary if you die – bypassing your will.
Within an investment bond, you can invest in shares, cash, fixed interest, and property trusts, like superannuation. This can be a tax-efficient way to save for the future and is particularly useful for long-term wealth accumulation. This will not be the best option for everyone and you should seek professional financial advice before considering this.
How to choose the right investment strategy
Choosing the right investment strategy depends on a few key factors:
a) What is your willingness to take on financial risk?
b) What kind of time frame do you have?
c) What is your goal and investment amount?
d) What is your risk profile?
Answering these questions will help you develop an investment strategy that aligns with your objectives. However, if you’re unsure or need guidance, it’s always a good idea to consult a financial adviser registered with the FAAA, who can provide expert advice tailored to your situation.
Tax considerations when investing for children
There are several tax considerations with this. Firstly, you need to decide what tax structure to hold the investment in. It could be your own name, a family trust or an investment bond. Holding the investment in a child’s name is generally not advisable, as it could trigger the unearned income tax rates for minors. This could result in them paying tax at rates as high as 66%. Additionally, there may be higher accounting fees due to the need for an additional tax return.
Common mistakes parents make
One of the biggest mistakes is not starting early enough. If you’re reading this and have been thinking about an investment for your child, start now. You can always adjust the strategy or even withdraw the money for yourself in the future. But if you don’t start, it will never happen.
Teaching kids about money and investing
In my opinion, one of the biggest advantages of starting an investment for your child is the opportunity it provides to teach them about money and investing. I’ve found that clients who begin investing for their children often return as clients themselves in the future. We use their child’s investment as a real-world example to teach financial literacy, providing practical education that isn’t just theoretical. This sets them up with good long-term skills and financial habits to carry throughout life.
The Money & Life website is operated by the Financial Advice Association (FAAA). The views expressed in this article are those of the author and not those of the FAAA. The FAAA does not endorse or otherwise assume responsibility for any financial product advice which may be contained in the article. Nor does it endorse or assume responsibility for the information.
