Make Your Kids Rich! Do this now…

Investing for your children is a great way to send your kids on the road to riches. Depending on how you invest for your children, whether it be through regular saving or a lump sum into a specific investment, investing for your children over a long period of time could see them hold a substantial amount by the time they reach an age to benefit.

Like all things, the earlier you can start, the better. So even if you are only saving/investing a few pounds each month, I hope this blog can give you some ideas on how you can set your child up with a healthy head start. I’ll talk about the kind of the things you can invest in and I’ll talk a bit about how my wife and I are investing for our son in his early years.

What to consider when investing for children

Risk and reward

Probably the single biggest question to answer is what result are you trying to achieve. How much risk are you prepared to take to maximise your potential gains.

Bank Savings

Right now the best bank savings rates are up to about 2.1% for fixed term savings and for limited balances. More general savings accounts offer between 0.1% and 1%. Since these offerings are from regulated banking institutions your capital is guaranteed and your returns also.

However, these rates are below the rate of inflation, which means in real terms, your money is depreciating in value.

Assets

Consider the long term history of the stock market. Over the last 100 years of so you could have seen returns, on average, of about 8-10% per year. However, these results are not guaranteed going forward and so to look for these much higher returns you need to take a greater risk. It’s entirely possible for stock markets to go into reverse and lose money over a year, two years or even longer.

Overall, though, you would expect that over the long term investing in assets would give you higher returns that investing with a bank for a fixed rate.

Much of the risk you are comfortable with taking, is likely going to be linked to how long you have to invest. Which brings us round nicely to the consideration of time.

Time scales.

The greatest asset you have when investing for kids, is time. This is because of compounding interest. While children aren’t likely to have much income from jobs or similar, they have the advantage of having many years in front of them to let their assets grow. I have an article on compound interest, you can read here, if you want to understand why time is so important.

This is why we say the earlier you start the better. The earlier you start, the more and more effortless compounding can take place.

In saying that, the length of time you want to invest is key in the choice of investment you will eventually make. Choosing something to invest in for a year, for example, would likely be very different to something you might choose for a twenty year investment. It’s also worth considering what you would do if you had to cut the investment time short for any reason and what the financial implications might be for that. Maybe there are penalties for exiting a fixed term product for example.

Tax

I’m not an expert in tax at all, but for the purposes of this article I’m thinking about tax free options for a Junior ISA. ISA is just an acronym for Individual Savings Account. Everyone in the UK can have one, and it’s just a way of investing tax-free. You don’t have to pay any taxes on any gains on investments up to a particular threshold. It differs for adults and children but I will talk about that a little later.

I mean, why not invest in this way? We get taxed plenty, so why not save a bit here?

Fees

Depending on how you invest, there may be fees. Every product will have different costs associated with them and you definitely need to factor these into your considerations. There may be one off fees or ongoing charges. Remember though, that fees are just part of doing business! Fees are part and parcel of life, just make sure you are happy with the service you are getting if there are fees involved.

Junior ISAs

I really want to consider Junior ISAs in this article. It’s what I have experience of and what I can talk about confidently!

What is a Junior ISA?

A Junior ISA is a long term investment account for children under 18 living in the UK, completely shielded from any kind of taxation. This is a lifetime of tax free investment, so well worth thinking about.

You can invest in one or both of a Cash ISA where the interest earned on the account is free from tax, or a stocks and shares Junior ISA where the any capital growth and dividends paid are free from tax.

Anyone with parental responsibility for a child can open a Junior ISA, and then the child can take control of the account from the age of 16. However they cannot make any withdrawals until they are 18 years old. Those who opened the account will have no legal right to the money, or any legal right as to how/when it is withdrawn and used – it is entirely the responsibility of the child when the account matures.

It’s a key thing to note that once money is deposited into a Junior ISA it is locked up until the child turns 18. At this point, the Junior ISA will become a full adult ISA.

What are the advantages of a Junior ISA over a regular savings account?

As already mentioned a Junior ISA is a tax free investment. So while you will pay tax on interest gained on funds in a current account or a savings account (however poor that interest rate is!) you will never pay a penny of tax for savings in a Junior ISA.

You can invest up to £9000 per child for the financial year 20/21 in a Junior ISA and that can be spread across a stocks and shares ISA and/or a Cash ISA. It will likely be the same next year.

Going for the cash option, then typically, because it is a longer term investment you could expect to get a higher rate of interest compared to a current account or other savings account. However, at the time of writing these rates are still very low.

Borrowed from Money Saving Expert, here are the best rates as at November 2021:

https://www.moneysavingexpert.com/savings/junior-isa/

What are the disadvantages of a Junior ISA over a regular savings account?

The only real disadvantage is that any deposits are locked until the child becomes 18. So if you were investing on behalf of a child you would need to make sure you won’t need that money for something else in the meantime. Further, that money is then the responsibility of the child when they turn 18, and if you are concerned about how that money would be spent then perhaps this isn’t the best way to invest.

A cash ISA will generally give you a fixed rate of return on your investment, whereas a stocks and shares ISA is tied to the stock market and will generate variable returns on your investment. It is possible to lose money investing in this sort of investment.

What do I do to invest for our child?

Currently we have invested in a stocks and shares ISA with Vanguard for our son. This has been going on now for about two years.

The stock market has historically returned between 6-10% a year since its inception over the long term, but in the last couple of years we have enjoyed growth far about that.

In just over two years, the growth is over 30%.
There will be ups and downs, but that is a great start for the wee man!

In any given year we could expect that figure to fluctuate and even return losses but over the long term we would expect to hit between 6-10% – which is much better than the cash ISA offerings at the time or writing.

Since he has around 15 years to go before he can withdraw his money he has plenty of time to let the stock market do it’s thing and grow, riding out any fluctuations that the market may throw up. Each year the compounding effect will help his money grow exponentially so that even if we didn’t invest another penny he could expect his deposits to grow into something substantial over time.

As I said, time and consistency are the two greatest things with investing. Currently there is £8089.80 in his account.

Take a look at the charts below.

5% Growth

Even at a lower than expected 5% annual growth, after 15 years he could expect to have nearly £17,000, tax free. Look how the interest is getting bigger each year as the interest is earned upon interest! Compound interest is great!

8% Growth

At 8% annual growth, after 15 years he could expect to have over £25,000, tax free. Look how the interest is getting bigger each year as the interest is earned upon interest!

8% Growth and investing more

Imagine now the same rate of interest at 8%, except we add £1000 each year for him… throwing in that investing consistency… he could expect to grow to nearly £53,000 by the time he is 18, earning close to £4000/year tax free on interest alone by that time. That’s the incredible power of investing consistently.

Summary

None of this is financial advice, but if you are thinking of investing for your child, then if your child is young enough, investing in the stock market might be the way to go. Cash ISAs will offer a guaranteed return but nowhere near the potential of stock market investing.

I’m not a financial advisor so you should consult a professional before making any investment decision.