Saving for Your Children’s Futures

24 May 2017  |  Simon Miller
Saving for Your Children’s Futures
The Bank of Mum and Dad is predicted to lend over £6.5 billion to children struggling to get on the UK property ladder this year.
Parents would be wise to start saving for their children’s financial futures as early as they can. Here are five tips for those parents keen to secure a sum that their children will be grateful for in future.

The ‘Bank of Mum and Dad’ is set to be involved in over 25 percent of UK property transactions this year according to recent research by Legal and General and economics consultancy Cebr. Over £6.5 billion will be lent to children struggling to get onto the property ladder, a sum already up 30 percent from last year.* Like it or not, it isn’t getting any easier to join the property ladder and parents are increasingly having to lend their support.

It isn’t just property that needs paying for, there are lots of ways that parents can help their children financially. No surprises here – the earlier you start to save for your children’s futures, the better. Here are some tips to help you secure your children’s financial futures.

1. Stay Clear of Cash

Those parents that are going to the trouble of saving for their children will not want their efforts scuppered by low interest rates and rising inflation.

Just in the past couple of weeks, inflation has jumped to 2.7 percent and the Bank of England has voted to keep interest rates at 0.25 percent. You don’t need a degree in Economics to see that when it comes to holding cash, the sums just don’t add up. Cash savers will find themselves with negative real returns (interest rates minus inflation).

A long-awaited interest rate hike won’t help diligent parents either, as inflation and interest rates tend to move in the same direction. Those early 1980s savers on a 17 percent interest rate weren’t doing quite so well when you take the 18 percent rate of inflation into account. Real interest rates were in fact negative.

Inflation and Interest Rates Tend to Move Together

High Interest Rates Don’t Benefit Cash Savers When Inflation Is Taken into Account

High Interest Rates Don’t Benefit Cash Savers When Inflation Is Taken into Account

There are no rich pickings to be found in cash savings. The value of £1,000 cash, in a bank account since 1995, would have increased by about 30 percent today in real terms. The effect of inflation offsetting gains from interest rates has prevented the value from rising any further.

By contrast, had a parent invested in the FTSE-100 Total Return Index, they would have benefitted from a rise of almost 300 percent over the same period. There will have been some ups and downs that the equity investor may have found difficult to endure but had they survived the turbulence, their portfolio would be in a much better position today than that of their cash counterpart.

2. Start Saving Now

The power of compounding. Something we investment managers like to talk about a lot, but not without good reason! It is the most valuable tool in investing and something that everyone can take advantage of as long as they have a decent time horizon.

An investor benefits from the effects of compounding when they keep any interest, yield or capital gains invested instead of spending it. These additions create much greater growth than would have been possible from the original investment alone.

The longer an investor stays in the markets, the longer their potential to benefit from the powerful effects of compounding. This means that the earlier parents start to save for their children, the better. Over 20 years and assuming a five percent annual return, the portfolio is 33 percent larger when compound returns are included.

3. Keep Up-To-Speed with Tax Wrappers

The limits and rules around tax wrappers do shift, so keep eyes peeled during the annual Budget for changes which may benefit you. The ISA and the SIPP are two valuable tax wrappers for UK resident adults to make use of but there are also specific tax wrappers for children if your allowances have been fully utilised. Junior ISAs are a government-backed product, offering tax-free savings for children. If your child is under 18 and living in the UK, it is worth maxing out the annual JISA allowance which is currently £4,128. Parents can open a JISA, but the money belongs to the child.

Projected Returns Over 30 Years

Parents Open a £15,000 Portfolio with a VaR of 10%

A £15,000 portfolio with a VaR of 10%

Parents Open a £15,000 Portfolio with a VaR of 20%

A £15,000 portfolio with a VaR of 20%

Based on historical returns (after fees) of a portfolio of Indices/ETFs from 2001 to 2016. Weights depend on the risk level.
Source of information: Bloomberg, own calculations. Past performance and future projections are not indicative of future performance. For more detail see our Investment Planner Methodology.

4. Don’t Be Overly Risk Averse

Investing your own money is one thing, but investing on behalf of someone else is quite another. You may be willing to take risks about your own future but more hesitant to risk that of your children’s.

However, the majority of parents investing for their children will have the benefit of a long time horizon which will help to cushion any market turbulence. Those parents investing on behalf of their toddlers will probably have 30 years until discussion of property ladders begins. This time horizon is long enough to weather some ups and downs and parents would be wise to invest for their children as they would for themselves and avoid being overly cautious.

Just a point to bear in mind, parents opening a portfolio on behalf of their children should be careful to specify the time horizon of that portfolio and not their own ages. Some investment managers will recommend a lower-risk portfolio if they simply look at the age of the parents without looking at the time horizon of the portfolio.

5. Remain Disciplined

If monthly outgoings start to overtake your monthly income, payments into your children’s account could seem an easy way to cut costs. After all, your children may be young and might not need the fund for 25 years.

However, thanks to compounding, a pound saved on behalf of your toddler is more valuable than one saved on behalf of your teenager. Where possible, do keep the child payments up. It might be sensible to set up a direct debit to ensure that the money reaches the children’s account every month.

Source: https://www.legalandgeneral.com/insurance/home/bank-of-mum-and-dad/Bank-of-Mum-and-Dad-Full-Report-2017.pdf

Image: Unsplash/Kychan

Risk Warning – With investment comes risk. The value of your investment can go down as well as up and you may get back less than you invest. Past performance or future projections are not indicative of future performance. We do not provide any investment, legal and/or tax advice. If this website contains information regarding capital markets, financial instruments and/or other topics relevant for investments of assets, the exclusive purpose of this information is to give general guidance on investment management services provided by members of our group. Please note our Risk Warning and the Website Terms.

 

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Simon Miller
UK CEO & UK CO-FOUNDER
Formerly a derivatives trader at Barclays Capital, Simon merges capital markets knowledge and business development skills with an academic background in Economics, Business and Mathematics.