Last week I wrote about some behavioural things you can do to help your children get on the right financial path from an early age. This week I am going to talk about investing and how starting early can set them up for the rest of their life.
There are two reasons kids should start investing early. The first is it is a good habit to get into. A habit that will serve them well for the rest of their life.
The second is starting early allows them to get the most out of compounding interest. Compounding happens when investors make interest on their interest. It is the best way to make significant long-term wealth.
To get the most out of compounding your kids need four things. Firstly, they have to save; they have to invest these savings and then re-invest any dividends/returns they make on their investment; they need to minimise the fees; and finally they need time, the more the better.
People can save more if they try. However, for most people, the more they earn the more they spend.
To illustrate this, a 2015-16 Australian Bureau of Statistic survey shows that people in the ACT had one of the highest average incomes and those from South Australia had one of the lowest. Not surprisingly, on average those from the ACT spent nearly 20% more than those from South Australia. However, if you look more closely at the ACT, the top 40% of people spent 60% more than the ACT average. Most of this was on entertainment, clothing and things that stop most people from saving.
The best way to save is to put it away before they can spend it.
Once your teenager has a job and a savings plan in place, the next thing is to invest the savings and then continue to re-invest any returns/dividends. Re‑investing the returns/dividends is the important part. Don’t let them take it and spend it.
As they are looking for a long-term investment, it is usually best to go for a high growth asset with low fees. For this, look at an Exchange Traded Funds (ETF), especially one that allows you to diversify across a broad range of assets. ETF’s let you invest in a wide range of assets (such as the entire Australian share market) with one trade and pretty low fees.
The reason you need to minimise your fees is because an annual fee of 1% can reduce your investment by more than 10% over a 30-year period.
Finally, you need time.
So here is a plan:
Help your 16yr old get a part-time job and save $2,000 per year; increase this amount to $10,000 per year when they are 22 and work full time; and every year invest these saving in a low-fee diversified ETF that averages a 7% return.
By the time they are 40 have done the hard work and can stop saving for this. By the time they are 50 their investment will be worth $750,000. When they turn 60 it will be worth $1.2 million. When they turn 70 it will be worth $2 million.
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