How to almost set a child up for life with $46 per week
A chance meeting at the golf course reveals the epic gift of early investing.
I recently turned thirty and did a bit of travelling around Australia to celebrate.
Before heading along the Great Ocean Road to Adelaide with my partner and her family, I called in to Melbourne for one last game of golf in my twenties with a friend from back home in Scotland.
Our fourball was rounded out by two fifteen-year-olds and, as it turned out, one of them had a rather keen interest in investing. Not because he was into stocks or fancied a career in finance, but because his Dad has been investing on his behalf since he was born.
Index funds for the kids
The kid explained that his Dad had put a small amount per month into two index fund portfolios - one earmarked for him, one for his older brother – since each boy was born. My advice to him? Thank your Dad when you get home. He has done you a wonderful service.
Let’s do some back of the napkin maths to see why.
Of course, I would never have asked how much his Dad contributed or what the portfolio value was today. So let’s just pretend that the parent contributed $200 per month for each kid from age 0 to age 18. Tough, but not unachievable.
By the time the kid turns 18, the parents will have contributed $43,200. Because they invested it rather than merely earning interest, it will likely have grown. At a fictional annual return of 7% per year, the portfolio would be worth just over $84,000 when the kid turns 18.
What follows isn’t a perfect comparison. But at the age of 18, each kid would have comfortably more in investments than the median superannuation balance held by those up to 20 years their senior, according to ATO data from the 2021-22 tax year.
.png)
Figure 1: Median super balances by age and gender. Source: ATO, 2021-2022 tax year
Now for where it gets really powerful. Because the great thing about investing early for a child isn’t really the balance at 18 years old. It is the superior use of time.
This is because the nature of compound interest dictates that your annual growth in dollar terms towards the end of a long holding period is far, far bigger than that in the earlier years.
Consider an investment of $10,000 that is held for 40 years. If I falsely assume linear growth of 7% per year, here is how the annual increase in value snowballs throughout the holding period:
Figure 2: Annual dollar increases in value over time. Source: Author
Earning an extra $10k on your principal used to take ten years. After forty years of compounding, it only takes one year. In the last five years, the value increases by $43k. The first increase in value of that size took over twenty-four years!
Getting to this level of the compounding game relies mostly on time.
This is something you can’t buy back but can make sure your children make the most of, even if they don’t know it. Starting them off early opens up investment time horizons and compounding possibilities that most people simply don’t have access to.
Have your cake and eat it too?
Of course, compounding in this fashion only works if it left unbroken. While that is easy to say as a thirty-year-old that just made the tables above, it is harder to feel that way as a teenager that knows they have a significant sum of money with their name on it.
Is there a way for our golf partner to enjoy some of the benefits of his parents’ foresight without throwing away all of his compounding advantage? I think there is.
Let’s imagine that the kid’s parents had invested $200 a month for him and that he ends up with a $84,000 in a portfolio at 18. A portfolio of $84,000 has the potential to deliver a not-too-shabby level of passive income from dividends.
These dividends could be spent to fund things like travel, experiences, or golf membership fees while the principal can remain invested and potentially keep compounding. Albeit with less power than if the dividends were not spent and were reinvested instead.
At the end of the day, it is up to the kid in our story and his parents to choose. But even knowing that these options are open to you at such a young age is a great start.
To learn more about the power of compounding and income investing, I would recommend the following articles by Mark LaMonica:
An important footnote
Investing on behalf of your children has tax ramifications. Most notably, the adult will usually be responsible for any taxes attracted by the investments until the minor turns 18.
For a guide to different options you have when it comes to investing for your children, read this article by my colleague Shani Jayamanne.
