Personal Finance

Saving and investing for your children

The dilemma

As a parent of young children, one of my main concerns is not just my own financial planning, but also planning for my children to give them a healthy financial start at a future point in their lives when money will become important for them – typically this is around the time they start settling down and looking to start a family, but I mentally work towards reaching my goals for them by the time the time they are 18.

I must confess that I have not formally begun their financial journey in any significant way. There is no real rush to do so given that they are still indeed very young and I haven’t quite mapped out what I think the best way is. What I suspect will happen over the next few years is a proper beginning of their financial journey which is likely to take place across different asset classes of varying degrees of risk.

I suppose the first thing to do with any journey is to have a goal. At the moment, I don’t really have a specific goal other than a general desire to be able to provide them with a pot of cash which will allow them to do something such as begin their own investment journey, contribute to buying their house, start a business, etc. At the moment, I reckon a decent sum for me at 18 years of age would have been around £50,000. The average rate of inflation for the first 18 years of my life was 3%, so it goes without saying that £50,000 in 16-18 years from now will not have the same impact – so in reality I should be aiming for the £80,000 mark for each child. This sounds like a lot now and time will tell how close I get.

I want to explore in this article – as well as contributions from you folks in the comments – how we might go about achieving this sort of thing. I imagine many of our readers are young professionals either with children or planning to have children at some point so there is real relevance here and the potential for some good shared thinking. Even if you don’t fit into that category, it would be great to hear from you.

Options

1. Save cash

The old-school way. This is the way my parents did it and probably most of their generation did too. The rationale goes that if you save £10 here or there and do it fairly regularly, you end up saving a surprising amount and this can be a great help for the child.

To be honest, I’m not a fan of this approach for two reasons. 1) You are unlikely to ever really save enough this way. 2) Even if you saved a decent amount of cash on a regular basis (e.g. direct debit to child’s bank account every month), the problem is that inflation eats away at the money.

So if I wanted to save £80,000 for one child over 18 years, I would have to save £370 a month. That’s actually feasible, even in today’s market of low wages and high rents, but my argument is that you’re not really getting value for money, as you could get to the £80,000 mark by putting in much less money than £370/month if you allocated money to some good investments that made money for you.

However, the real benefit with saving cash – and this is why it’s the default for the cautious person – is that cash is king. It is not reliant on stock markets or property markets, etc, it’s just there sitting in the bank, ready to go. Save for some sort of institutional financial disaster, this is probably the safest way to go about saving for children.

Am I likely to use this approach? Maybe. I can see it being really useful if I get to, say, year 14, the £80,000 goal is near, and I want a really safe route to get the goal rather than putting it into an investment that might be less safe. But at this early juncture, I think it has limited use for me.

2. Invest in property

Now this is something I’m seriously considering.

The great thing about property is that you can get leverage from a bank. We’ve explored in some detail here on IFG our position on Islamic mortgages (Islamic Mortgages explained), so we are using its permissibility as a base assumption for this article.

Property is often seen as great because of its tangible and unique nature (even in a depressed housing market, your property is still there in existence, and by definition every property is unique). Investors have also traditionally loved property because it very easily pays for itself.

This makes leverage all the more attractive. Let us take the example of a £100,000 property. Assuming a 5% net yield, it would bring in an income of £5000 a year. Assuming you put down a 20% deposit of £20,000, you would pay off the capital amount of the mortgage within 16 years. You would take slightly longer to pay off the mortgage in reality as you’d be paying the bank some of the rental income.

Whilst the figures would need tweaking and working out exactly for each individual case, this is an attractive proposition for me. I say that, because putting down a £20,000 deposit is very realistic, and for that, you can sit back and let the income pay off the rest of the mortgage.

Let’s say everything has been paid off within 18 years, you could then even afford to pay yourself back your initial deposit contribution over the next 2-4 years. I say 2-4 years, because it is likely that in 18 years’ time, the rent amount will have increased, but your £20,000 contribution has not increased. So if the property is bringing in £7,500 instead of £5,000, you’d only take around 2 and a half years to pay yourself back.

So with these very rough calculations and assumptions, we can say that within around 20 years, both you and the bank will have been paid off and you will have the house.

This house was worth £100,000 when you bought it today, but could well be worth more in 20 years. For instance, the real average price (i.e. taking inflation into account) of a house in the UK in 2000 was around £127,000 against around £205,000 in 2016, so a real return of around 60% – a superb return.

So you could hypothetically have a situation where you have an asset at the end of the 20 years or so which is worth over £100,000 and it has cost you nothing. This sort of investment demonstrates the beauty of time and how future planning can help tremendously.

The child would then have this asset ready to use: they could either continue to take the income and simply accumulate or sell into the market and use the cash. They also have a ready-made security against which they could lend further money from a bank – an enviable position for a young person.

Am I likely to use this approach? I think so, yes. Unless someone can point out a major flaw with this, I’m struggling to see any downside.

3. The stock market

Shares present a very interesting opportunity for the long-term investor. I have written before about the value of getting acquainted with the stock market and picking stocks for yourself. I believe people who take a hands-on approach to investing and finances have a vested interest in taking the time out to do this rather than paying somebody to do it. However, time is a precious commodity and given that there is no guarantee of you picking good stocks, many might prefer to simply stick some money in a fund and leave the professionals to it – and I understand that.

Whichever approach you take – paying somebody to manage it, or picking stocks yourself – the stock market can offer some seriously good returns. You can vary your risk appetite within the stock market too: so if you want the potential for huge returns (and the risk of huge downfalls), then small-cap stocks are almost unique in their potential. Equally, the FTSE blue chips with safe dividends are more suited to those who can’t quite bear that risk. And of course you can have a mixture of these different types of stocks so that you limit your downside but also have enough invested that a big return will add very nicely to your overall portfolio.

At this early stage of my kids’ financial journey, I find the stock market quite compelling. The idea that I could find a young, up-and-coming company that could one day be a giant, could single-handedly realise my financial goals. For instance, buying Amazon on the first day of trading – even at the day’s high of $29.25 – would have landed you an incredible return by now. $5000 (£3856) worth of shares back then (May 15, 1997) would be worth over £1.5m today. Admittedly, the chances of both finding a stock like that and holding on so long are slim, but it does go to show the prospect and allure of the stock market.

On a more realistic level, the slow and steady approach could also bear fruit in the stock market. If you managed an average of 8% a year, you could return around £23,000 over 20 years by starting off with an initial £5000. Obviously, you could return higher than this by adding more to the pot as you go along.

One of the main factors putting people off the stock market is concerns about sharia compliance. We can certainly help with this via our consultancy service.

Am I likely to use this approach? Probably. I think I’d have a separate allocation for the high risk stuff and a separate allocation for the slow and steady and weight them accordingly (i.e. more money in the lower risk stuff).

4. Non-traditional options

The above 3 options are of course the typical 3 asset classes that first come to mind when anyone talks about investing. But there are lots of interesting investment types knocking about nowadays that merit further investigation.

For instance, a good way to have access to returns on property without having to raise the initial capital for the deposit or worrying about mortgages etc is to do it via one of a number of property crowdfunding websites now available. However, to make it worthwhile, you are of course going to have to invest a decent amount so you might end up just preferring to save up for a deposit and buying your own property.

Another interesting alternative is to find a few like-minded people, and pitch in together to buy a property. You would all have a share in it and you could get access to part of a property income without taking out a mortgage.

Other interesting options include things like investing in startup businesses that aren’t on the stock market. These are often young companies needing start-up capital as they begin their journey and who one day hope to be big, profitable companies. If you have a little stake in that sort of company and they achieve their aims, that could be huge. However, this is inevitably very high risk due to the sheer number of businesses that fail very quickly and you will see nothing of your money back if this happened.

Conclusion

I think what will probably happen personally is a mixture of these asset classes. For instance, I could save some cash and use it as a deposit on a property, put some into a stocks and shares junior ISA, and maybe even just save cash towards the end as the kids get older. As years go by, I might consider re-jigging some of the money into non-traditional options that arise.

The point is that I fully intend to be proactive about my children’s finances over the next 18 years or so that they have a good pot with which to begin their adulthood.

Another thing I’m considering – and this is entirely dependent on the commercial aptitude they show as they grow up – is to actually allocate some money to them and give them some entrepreneurial responsibility and ownership over their own future.

Over to you

I’m really interested to see what you have planned for children’s savings/investments so let’s explore those in the comments.

Don’t forget that we can help you with sharia compliance advice via our consultancy page which is particularly useful for stocks and shares, as well as structuring custom solutions like joint ventures etc.

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  • All this comes down to the assumptions, of which there are quite a few.
    And of course the maths.

    Personally, I’m going to put my £20k into my pension pot, get the tax uplift and let the stock market do the rest.

    The break-even (on my numbers not yours) vs property is 8.5% annual share value growth as a basic rate taxpayer, and 7.9% as a higher rate taxpayer.

    (Lots of assumptions used).

    Reply

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