Investing on behalf of your children can be a great way to give them a head start in life. But in an uncertain market environment, and with myriad investment options out there, it can be difficult to know where to start. In this article, Dominique Ellis, CFA, offers some key pointers.
Read this article to understand:
- The principles of compound interest and market investment
- Why investing has long-term advantages over saving
- The benefits of the Junior ISA when investing on behalf of children
Parenting is one the most exhausting of human experiences. But it is also without a doubt one of the most enriching. Kids are great fun (who doesn’t love an excuse to pull out the super-soakers again?) but being the adult also means taking on certain responsibilities that may be less of a game – and we are not just talking about joining the school WhatsApp group.
Parents want to provide their kids with the best start in life and do what they can to set them up for the future. Investing on behalf of your children is a great way to build up a nest egg for future expenses: their first car, university fees, a foot on the property ladder.
Arguably the need for a parent to step in to help with these expenses is increasing. Take housing. First-time buyers are being forced to accept smaller homes at much higher prices relative to average salaries than in the past (data from Yorkshire Building Society puts the multiple at 6.04 times in 2024 compared to 2.5 times in the 1970s).1 An average deposit of ten per cent is also much harder to raise today than it was historically, as it now amounts to more than half of typical annual earnings.
Moreover, the benefits of investing for your children go beyond the obvious. Today’s cashless society makes it tougher to understand the value of money – and academic research suggests children as young as seven develop lasting financial habits through the influence of their parents.2 By involving them in the process, investing for your children can be a powerful way to teach them the importance of money management and provide them with life-critical skills.
The following are some useful tips for increasing your chances of success.
1. The early bird catches the worm
Those first months (potentially years) of parenthood commonly involve lots of adjustment; it feels a continuous process of trial and error, not to mention growing piles of laundry and endless sleepless nights. With these challenges to grapple with, taking time to reflect on your financial affairs may not feel like an immediate priority, but as soon as you get going, your child's money will begin benefiting from the power of compounding, or earning interest on top of interest.
Compound interest can significantly boost investment returns over the long term
Compound interest can significantly boost investment returns over the long term. This is illustrated in the chart below, which shows how the annual interest on a £9,000 initial investment grows due to the power of “interest on interest”. This phenomenon means that, if you start investing when your child is born, by the time they are 16 the annual interest on that investment will be double what it was in year one. This may seem a long time to wait, but growing your wealth takes time and patience.
Figure 1: Annual interest earned over 18 years (£)
Source: Aviva Investors. Data as of August 13, 2024.
Another way to think about the power of compounding is to use “The Rule of 72”. This a simplified formula that calculates how long it will take for an investment to double in value, based on its rate of return. If an investment returned an average of six per cent per annum, by dividing 72 by this number, we can work out how many years it would take for our money to double (12 in this case).
The benefits of compounding are magnified by adopting a consistent and tax-savvy approach to investing. A Junior Individual Savings Account (ISA) is a handy vehicle to use to build up a child’s nest egg. Under UK rules, each year you can pay up to £9,000 into a tax-free savings account (as of the 2024/2025 tax year), whether this be into a junior cash ISA, a junior investment ISA, or split between the two.
There is, however, a warning here – look out for fees. If you’re compounding your interest, you are also compounding the cost of paying fees, so it is important to look for low-fee or, ideally fee-free investment options.
2. Don’t put all your (nest) eggs in one basket
Investing differs from saving as it involves putting money to work over a longer timeframe to take advantage of higher market returns. Parents may be wary of investing because they’re worried about the risk of losses. They might lack confidence or feel they don’t have time to monitor their investment.
This caution isn’t surprising – when markets fall sharply, they tend to make headlines, as we saw during the market gyrations of early August 2024. The fact that, over a longer time horizon, markets tend to rise more than they fall isn’t deemed to be newsworthy. This imbalance in coverage means we can overestimate the likelihood of market falls and may be put off from investing in a manner that meets our financial goals.
The past few years have ushered in heightened market volatility and also a level of inflation not seen for three decades. This bolsters the case for investing, as inflation erodes the purchasing power of your cash. To put this into context, in 2004 the UK’s hourly minimum wage for an under 18-year-old would buy you a stash of 30 Freddo chocolate bars; fast-forward 20 years, and a teenager earning the minimum wage would have the ability to purchase just 17 of these treats. Inflation matters.
In the context of inflation, even if you consider yourself fairly risk-averse, just sticking your money in the bank doesn't often make sense
If you’ve become a parent during this timeframe, saving and investing against a backdrop of inflation may be relatively new to you. It’s possible that the prolonged period of low interest rates and inflation will have influenced your thinking – as it has for professional investors – and that you’ll be hard-wired to underestimate inflation. As a consequence, you may not be as inclined to recognise the need to invest rather than save. But in the context of inflation, even if you consider yourself fairly risk-averse, just sticking your money in the bank doesn't often make sense (see Figure 2).
If you’re investing for your children’s future, and can afford to lock away your money in the short to medium term, you should be in a position to take more risk and, as a result, enhance potential returns. This is because your portfolio has time to recover from any perfectly natural market dips that might occur along the way.
Figure 2: Saving versus investing over the long term (per cent)
Past performance is not a reliable guide to future returns.
Source: Aviva Investors, Bloomberg. Data as of July 31, 2024.
If volatility is still a concern, a useful way to approach the risks involved in investing is to diversify. Multi-asset funds can be a good idea if you want to improve the risk-return profile of your investments. These funds can give you access to a selection of assets, including bonds and equities, within a single investment, and help you avoid too much concentration in any asset class or sector. While it may be tempting to load up on tech stocks if you see they’re doing well, this can be a hazardous strategy, as the tech sell-off at the beginning of August illustrated.
Multi-asset funds can be a good idea if you want to improve the risk-return profile of your investments
Another reason spreading risk in this way can be helpful is that asset classes tend to perform differently from one another when the macroeconomic context changes. For instance, a change in interest rates, such as the Bank of England’s base rate cut to five per cent on August 1 – is an example of a change in policy regime and will have knock-on effects for the price of different assets. Typically, you can expect to see equities outperform bonds when interest rates go lower.
3. Little and often fills the purse
Another concern often raised when someone is deciding to invest is market timing. This can be particularly important in the context of a volatile market and at times of geopolitical uncertainty. Market peaks and troughs can prompt questions. Have you bought in at the peak? Should you wait a little longer?
Pound-cost-averaging is a useful strategy to remove this anxiety. It refers to the process of buying shares of a stock or fund in equal pound amounts and at regular intervals. By investing a specific amount over time and in equal-sized chunks rather than a lump sum all at once, you end up buying more shares when prices become cheaper, and fewer when they become more expensive. Any worry over not timing the market accurately is removed, as you adopt a degree of investment discipline and use a systematic approach to how you buy. In this sense, you are able to think of market upsets as an opportunity.
When you have a separate fund established for your children, you will minimise the chances of sacrificing some of your retirement fund for them
Think of it as filling your own cup. If setting your kids up for success isn’t motivation enough, then consider things selfishly: investment for your children also contributes to a hassle-free retirement for oneself. When you have a separate fund established for your children, you will minimise the chances of sacrificing some of your retirement fund for them. Start investing for your children early, in a tax-efficient, risk-appropriate way – such as through regular payments into a JISA – and you’ll drastically reduce your chances of taking up a twilight career behind the counter at the “Bank of Mum and Dad”.
Multi-asset investing through a JISA
For those parents hoping to follow the principles outlined above, a Stocks & Shares JISA may be an attractive option. Some JISAs are fee-free, meaning there are no service charges for opening an account or holding cash (this is not the case with all providers). Depending on the funds you choose to invest in, there can still be other fees for share dealing and stamp duty, for example, so it is important to look for a strategy offering good value for money.
Aviva Investors’ MAF Core range can offer a way to avoid putting all your eggs in one basket by diversifying across assets
A JISA can provide access to multi-asset investing strategies. Aviva Investors’ MAF Core range, for example, can offer a way to avoid putting all your eggs in one basket by diversifying across assets. The MAF Core range offers a passive, low-cost solution that adopts a flexible and global asset allocation, investing in over 4,000 securities, including access to active Global High Yield and Emerging Market Debt. These asset classes can provide higher levels of income and are not usually included in similar strategies.
Consider Figure 3, which takes the broad range of assets the Aviva Investors MAF Core range invests in and illustrates how differently the investments perform year-to-year. Combining these assets in a single portfolio can therefore help spread risk and smooth returns, potentially helping to beat inflation (see Figure 4).
Figure 3: Return across different asset classes in MAF Core
Past performance is not a reliable guide to future returns.
Source: Aviva Investors. Data as of December 31, 2023.
Figure 4: Historical simulation of MAF Core versus inflation (per cent)
Past performance is not a reliable indicator of future performance.
Note: The simulated performance of the MAF Core funds pre-November 30 2020 is gross of fees. The effect of fees and expenses reduces overall performance. MAF Core performance post November 30 2020 is actual past performance and is net of fees. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. Cash is modelled using the SONIA Base Lending Rate. Inflation is modelled using UK CPI.
Source: Aviva Investors, Morningstar. Data as of July 31, 2024.
Investing in a multi-asset fund like MAF Core also means you can select the type of fund that has a risk profile to suit your individual risk appetite. The funds aim to stay within a pre-specified level of risk, which can be reviewed to ensure that it remains appropriate for your needs.
These options offer a way to diversify your assets and take the amount of risk that is suitable for you and your family. Added to the tax-efficient model and ease of use of the JISA account, this should offer peace of mind. So, while your kids might not let you sleep at night, your Junior ISA will.
