You may not have the cash right now, but you’ve got plenty of time if taxes, fees, mistakes — or the child — don’t steal your thunder.
I stumbled upon this article by Liz Pulliam Weston while checking my hotmail account. After reviewing this article, I decided to post for readers on my web log who’re about to or already have kids.
Call it the ultimate Christmas gift for your child: a cool N1 million.
It’s a lavish gift, but not a prohibitively expensive one. A monthly contribution smaller than your current cable TV bill, made faithfully until the child turns 18 and then left to simmer until retirement, will hit seven figures without outlandish investment choices.
A newborn has nothing but time — and that’s something this strategy exploits to the fullest. Let’s say a 30-year-old manages to save up and then invest a lump sum of N100,000. At an annual return of 8%, by the time she’s 65, that N100,000 will have grown to nearly N2,800,000. Not bad, right?
But then compare it to what a 5-year-old could make from the same N100,000. The extra 25 years of growth would give him over N4,800,000 by age 65. A newborn would end up with N5,200,000.
If you don’t happen to have N100,000 handy, not to worry. You can get the same results with a monthly investment, made even smaller if you can persuade your child to keep the contributions up over the long haul.
Take a look at what’s possible in the table below. All the examples presume 8% average annual growth, a reasonable return from a diversified mix of stocks, mutual funds and cash.
To accumulate N1 million by age 65:
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Starting at:
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One-time contribution
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Monthly contribution until age 18
|
Money at age 65
|
|
Birth
|
N100,000
|
N8,333
|
N5,200,000
|
|
Age 5
|
N100,000
|
N8,333
|
N4,800,000
|
|
Age 10
|
N100,000
|
N8,333
|
N4,400,000
|
|
Age 15
|
N100,000
|
N8,333
|
N4,000,000
|
|
|
|
|
|
Pretty neat, huh? I’ve heard from quite a few parents excited about the possibilities. Many believe their own financial futures were stunted by not investing early enough, and want their children to avoid the same mistake.
But there’s a downside. While time can help the young grow a fortune, it can also magnify any investing mistakes made along the way. If that 5-year-old’s account is traded excessively, charged high fees or invested too conservatively, the nest egg may be dramatically smaller.
If our youngster eked out only a 6% annual return over time, for example, his account would be worth just N3,900,000 at retirement age.
Furthermore, your kid’s wealth accumulation plan could cause havoc with future financial-aid packages, so you’ll want to know how to minimize the impact.
Who’s a good candidate?
As nifty as the math is, you shouldn’t start building your children’s fortune until your own financial path is secure. That means all of the following are true:
- You’re on track saving for your own retirement. No matter how much you want to secure your child’s financial future, you must attend to your own first. (Your kid won’t thank you for your largesse if she winds up using it to support you in your dotage.)
- You have no consumer debt. Again, you want to be on sound financial footing yourself before helping your kids, and that means paying off the credit card balances, unsecured personal loans and any other high-rate debt.
- You’re saving for college. That futureN1 million won’t mean much if your kid doesn’t get a good education or winds up saddled with massive financial student loan debt.
- You’re willing to spend some time educating your children about money. For the million-naira plan to succeed, your children have to understand the importance of keeping their mitts off the money so it can grow. They need to know that every N1,000 they withdraw at age 21 will cost them nearly N30,000 in future retirement money — plus any taxes and penalties that may be owed for tapping the money early.
If you’ve got your financial bases covered, then you can proceed.
What about taxes?
Lots of expensive financial products are sold to people who panic unnecessarily about the effects of taxes on their investments. While it’s true that taxes over time can reduce your investment returns, they’re easy enough to minimize without paying a small fortune in fees to stockbrokers or insurance companies.
What tends to generate big tax bills is excessive trading, either by professional mutual fund managers who take a so-called “active” approach to investing or by the parent or grandparent managing the account.
Also, with a broad-based stock market fund, you’re pretty much guaranteed to do at least as well as the overall stock market. Compare that to the two-thirds or so of actively managed funds that fail to beat their indexes over time, and you’ll see that index funds are a pretty good choice.
A big drawback: These funds, like most mutual funds, have pretty hefty minimum investment requirements that can be problematic for folks investing small amounts. IBTC’s ethical funds/mutual funds require a N50,000 minimum purchase; Fidelity Coral, UBA & other discount houses offer similar packages.
Additional account fees may be charged if your balances are below certain amounts.
Other options: buying and holding individual stocks or exchange-traded funds (ETFs). ETFs, like index funds, are bundles of investments meant to mimic a benchmark, but unlike funds — which are traded once a day — ETFs trade like stocks throughout the day.
Buying ETFs and stocks through a brokerage can get pretty expensive, though; trading fees will eat up a good chunk of your monthly investment. A cheaper alternative: invest in individual stock holdings for the long-term..
Yet another possibility: buying shares directly from the companies, avoiding commissions. Minimum purchase requirements and fees, though, vary widely by company.
What bucket to use
Here’s an issue that actually is important: minors generally aren’t allowed to hold investments in their own names. But each alternative has its cons as well as its pros. For example:
I usually suggest that parents should buy the stocks in the child’s name. At maturity, the stocks can be transferred to the child who assumes control of the account.
A joint savings account. These are pretty easy to set up, but may have tax issues. The same kiddie tax rules apply: If the account earns your kid more than a certain amount (check with your local bank), withholding taxes must be paid at your rate. Also, the account is considered jointly owned for college financial aid purposes, so half of it (your kid’s half) will count heavily against you.
Life insurance. Bleah. Kids don’t need life insurance, and your money will go a lot farther if you’re not paying for insurance you don’t need, plus commissions and an insurance company’s overhead.
Making sure they don’t blow it
What if you’re worried about your child raiding the money prematurely? Your control is limited with all but one of these options: holding the investments in your own name. Otherwise, at some point — certainly by age 25, if not before — your kid will have access.
If that unnerves you, you can either opt to keep the funds in your own account or spend a substantial wad on elaborate trusts designed to dole the money out over time.
But bear in mind that your children’s future fortune will be worth less than N500,000 at age 18. The real growth will come over the following decades. While prematurely raiding their cache might prevent them from achieving the million-naira kitty you want them to have, it’s not like they’d be able to spend seven figures on a car or decorating their dorm rooms.
Today's Naira 