We are thinking of investing for the kids, how should we do this?
This is undoubtedly one of the most frequently asked questions I get as an adviser to many ambitious families.
They have money sitting in a bank account and are thinking about doing something with it for their kids.
For most parents there is a lack of clarity on the purpose for investing.
So before taking any further action it’s worth reflecting on why you want to do this in the first place.
There are 3 main investment purposes I have seen when it comes to kids and money.
Grow to provide.
Grow for their use.
Grow to teach.
Let’s look at each.
Grow to provide
The concept is simpler to when you get on the flight and the safety video takes you through what to do in an emergency. It says a few times to put your oxygen mask on first, before you look to help others. Because if you stop breathing you can’t help anyone.
Caring about your kid’s future is easy for most parents. But what about you or your partner. Are you actively investing yourself today?
It’s more important to get this sorted because it has the benefit of showing your kids the freedom that comes from investing.
Showing them that you don’t need to “trade time for money for life” is a life changing lesson.
When most people invest for kids they keep it small, usually it’s a small amount relative to family income, and usually the last money to be allocated after they spend the rest.
Paying yourself first (investing first) flips the script, allocate money to investing and then allocate the rest to your life.
“Grow to provide” is concept of investing money which you as a family unit plan to use to help fund something for the kids, or the wider family. This could be high school fees, university fees, an overseas trip or helping them fund a home deposit.
The aim is for the money to be used at some point for something, likely not to pass onto them so there is not the need for the complexity of a legal transfer of the whole amount.
The problem most people face by not investing, or failing to grow a sizeable portfolio, is that they are falling for an emotional basis called mental accounting.
Mental accounting is a behavioural bias that leads people to make financial decisions based on emotionally charged considerations rather than on rational ones. It causes people to irrationally allocate their resources in a way that does not maximise their financial well-being.
A simple example, if you have a bank account with a kids name on it earning 5%, but you have debt that is charged interest at 6.5%. The better outcome financially for your goal would be to have this money paying off the debt or in an offset account. The only reason it’s a separate bank account is to make you feel like you have accounted for your kids, it however may be working against the overall objective.
The main problem comes in the long run with this limiting bias.
Investing is fundamental part of achieving financial freedom, by limiting your investment just to some accounts for the kids you could maybe make ten of thousands… but there is potential for you to grow your wealth in the hundreds or thousands, and with time on your side it could be in the millions.
What’s the best option?
Don’t overcomplicate it.
Simply look at your financial plan, you and your adviser should have detailed out where your next dollar goes, and this will give you to best change to provide for your kids in the future.
The sooner you invest, and the more regularly you invest the more options you will open up.
Grow for their use
The concept here is a level pegging.
Whether it be schools or housing there are plenty of parents out there investing for there kids. This means there is an unfair game for those entering adulthood, those that come in at zero and those then come in with enough to make the first move.
There are loads of ethical and political considerations here but you need to consider your environment. I have for example seen lots of families in the eastern suburbs of Sydney or Melbourne be frustrated that their kids are not moving of home despite the fact they have raised their kids to live in the most expensive areas in the country and not looked to provide any support.
When the kid’s peers are mostly getting help to enter the same housing market for example, it creates an uneven playing field.
Entering adulthood won’t be fair but it’s whether you want to provide opportunity for them or leave it up to themselves to sort it out.
If you are thinking of passing on the investment portfolio to your kids legally, as opposed to just giving them income from your wealth, then there are two additional complications.
The ability to transfer legal ownership. You likely want to avoid unnecessary taxes like triggering capital gains on the transfer of ownership.
The other, if you have multiple kids is keeping things fair, whatever fair means to you.
Let’s look into each.
Firstly, the ability to transfer assets without triggering capital gains really comes down to getting the structuring right upfront.
Some families with more sizeable amounts of money will use family trusts for this purpose, other will purchase an investment or set up an account in their name in trust for their kids, a form of informal trust.
“In trust” means that for tax purposes the assets are in a parents name until the kids reach the age of 18 and then assets can be transferred legally to their name, and they become responsible for the management and tax considerations.
Buying shares or other investments “in trust” is a common approach with legal ownership transferring at age 18. Note, buying an investment in your name and then retrospectively trying to put into trust generally won’t work, this should be done at the time of the initial set up.
Other options include education bonds or investment bonds which provide the ability to buy in trust but provide some additional tax benefits. This is beyond the scope of this article but any decent adviser can help you rule in or out this option depending on your tax situation.
Next complication is only relevant if you have more than one kid.
It’s about keeping things fair, whatever fair means to you.
Isn’t it simple and you put away X dollars per kid?
Well maybe.
But what if there has just been a major downturn and recovery in the market like 2008 or 2020, and the $10,000 you invested is now $15,000.
A few years later you invest $10,000 for you next kid.
The timing of the initial investment matters, the first child’s account could be close to the $30,000 when the second child’s portfolio is still closer to $15,000.
In reverse what happens if you need to draw down money when one of kids entered high school or university but it’s a down year on the market.
How do you solve this?
Firstly, define what your version of fair is.
Is it “you get what you get and don’t get upset?” or is it an active strategy to allocate money over time to ensure the timing the initial investment is mitigated.
This could be via dollar cost averaging purchases of investments over a longer period of time to smooth the purchase costs.
This could be uneven purchases each kids account along the way to even things up.
It’s worth considering how money can impact your relationship with your kids, or more importantly how it can impact the relationship between kids if these things are not considered.
This is why family trusts are so popular when serious wealth is involved as it can provide flexibility down the road to distribute money to the next generation.
Summary of main options:
Set up a family trust to hold investments.
Purchase individual investments in trust, usually in one of parents name.
Use alternatives like education of investment bonds.
Grow to teach
As the saying goes “Give a Man a Fish, and You Feed Him for a Day. Teach a Man to Fish, and You Feed Him for a Lifetime”.
Assuming you are investing yourself then setting up an investment to teach is a great way to follow this adage.
The key to making this concept work is engagement. If you are not investing yourself then you might pass on the wrong message as you see up’s and down’s in the price of an investment.
Every kid is different so the approach across your family may differ.
It could be as simple as purchasing an index type investment that purchases every share in a wider index, and then check in once a month to show them how it is up, or down, and how over the long run it increases in value.
Some kids might show more interest so you might get their help in deciding how much to invest and how often.
Others might show a real interest and you may consider even investing a particular company’s stock.
There are lot’s of sensible arguments to say most people shouldn’t invest in direct shares, and rather buy something like an index fund with a whole lot of companies.
For me this sensible investment advice might not peak engagement which is the aim here.
Saying to a kid you own the ASX200 is different to saying you own some of say a company like Coles, where they do our shopping every week.
It’s teaching them the lesson of owning businesses rather than shares is the real game changer. Teaching them that they can buy businesses which provide them money for the risk taken.
The reason I used Coles in the example relates to a client of mine from from many year ago.
He helped his son buy some shares, the son got really engaged in investing and ended up owning lots of shares.
He was putting away his nearly his full pay every fortnight.
He later got a part time job at Woolies but he in fact got paid more from a rival company Coles.
He didn’t work for Coles but he got paid dividends from her his Cole’s shares.
Start by assessing engagement with your kid and adjust how deep you do based on this.
If you are interested in investing then trying to push this on your kids can have the opposite effect of intended purpose.
Start slow, track engagement and then adjust.
Summary
Know your purpose before you start investing.
Take some time to consider what you actually want your kids to get out of this process, this will help you get tp your answer.
Want to know more?
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The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.