Sarah Megginson explains how shares can help build financial security for your children.
Getting your kids started with a savings account to grow their wealth is like planting a seed. We have the best intentions. We want the account to grow and be fruitful. Sometimes we’re even successful at socking away money… for a period of time. But then life gets in the way. We dip into the money for an emergency, or we stop contributing for a while when the daycare fees start piling up. The account doesn’t get very far, and before long we realise it’s been dormant for a couple of years.
But we can’t expect that tree to bear fruit if we’re not cultivating it correctly.
Of course, everyone is starting from a different base in terms of how much money they can afford to invest for their kids. Especially if you’re a solo parent or part of a low – or single-income family, you may feel that kind of consistency isn’t possible.
But the thing to focus on most with a savings strategy for your kids is this: you don’t need to invest a lot to have an impact. In fact, whatever your starting position is right now, whatever your background is, what matters most is what you do next.
If you can afford $2 every week, then that’s where you start. After 40 years, contributing $2 a week and assuming an average return of 5% per annum, you’d have just over $13,000. That could be a life-changing gift for your child at the age of 40 – helping to pay for medical procedures, buy a small car, start a business, cover an emergency expense or simply provide a financial safety net.
As time passes, if or when you’re able to nudge it up by another dollar a week, do that. Maybe you stay on $2 for five years, but after that time you get a pay rise and decide you can afford to increase it to $5. You share what you’re doing with grandparents, and every now and then they chip in $50 or $100.
If you’re able to set aside $5 a week in a savings account earning 5% interest per annum, that could mean a balance of $33,000 in 40 years. If you can manage $10 a week, this doubles to $66,000.
»» Bottom line? How much you start with matters less than how consistent you are.
There are two main types of bank accounts:
Transaction account:
For spending. This is an account that usually comes with a debit card, allowing you to spend money easily and withdraw cash. Interest rates are generally very low because you don’t usually keep large amounts of money in it.
Savings account:
For savings (funny that). This type of account is unlikely to come with a debit card, because easy access to your cash defeats the purpose. Interest rates can be relatively high.
What are shares?
Investing in shares can be a great way not only to help build financial security for your kids, but also to help teach them about money, investing and compound interest.
So, let’s say you’re keen. You’re a parent or loved one who wants to start investing in shares on behalf of your child, grandchild, niece or chosen family. How exactly does it work to invest in shares?
When you buy a share, you buy a tiny slice of a company. You become a part-owner – albeit an extraordinarily small-scale one – alongside thousands or millions of other part-owners. To put it in perspective: imagine the company is a four-bedroom, two-bathroom house. When you purchase one share, you own one tiny two centimetre by two centimetre tile in the second bathroom.
»» Should you invest in a capital growth share or a share that pays dividends?
If you buy shares in a company like Apple, that house might be quite a bit larger – say, a 20-storey hotel – and your one share equates to one small tile in one of the bathrooms in one of the hotel suites.
So, yes, your ownership is very small. And you can’t influence the shape of the company at all. Because you only own the equivalent of a bathroom tile, no-one’s going to listen to you if you say you think the walls should be repainted. But you do own a small piece of the business as a holder of a share, and businesses usually like to please their shareholders.
When you choose a company to invest in, there could be one million shares available and you own five of those shares – or you could own 50, or 500, or 5,000. You might own your shares alongside millions of other everyday investors just like you and/or someone uber-wealthy, like Elon Musk; he owns 412.6 million shares in Tesla. This means he owns about 13.04% of the company’s shares because, in total, there are around 3.2 billion shares in Tesla available.
How you make money: dividends vs growth
Obviously, the purpose of investing in shares is to make money, and that can happen in two ways:
1. The shares increase in value
You buy 10 shares at a price of $10 each or $100 in total. Over time, if the company does well, it makes more money, employs more people, launches new products and grows to become more valuable. Other people want to buy into it too. All of this drives the share price up. Your shares go up in value from $10 to $15 each, so your overall shareholding has increased from $100 to $150. This is called capital growth.
Some people make big money out of share investing, because they’re not buying $100 worth – they’re buying $100,000 or $1 million worth. Or if they’re institutional investors, they’re spending 10s of millions. As mere mortals with everyday incomes, we don’t have their buying power, but we do have access to many of the same shares they buy.
To make a clear profit, you need to sell the share. In our example above, you’ve made $50 on paper (not counting any small trading fees). But that wealth isn’t ‘crystalised’ – the value of those shares could fall at any moment and your profit could fall. To access that profit, you need to sell the shares and withdraw your money. (usually, with most investing platforms, you can access your money one or two business days after selling your shares). Once you sell them at a profit, you’ve made a ‘gain’ in capital growth terms and you’re required to pay tax on that. But we’re not going to worry about any of that just yet, because we’re talking about investing for your kids’ future – which means holding on long-term.
2. Dividends are paid
There’s another way to profit from shares. Some companies generously share their profits with you along the way by paying a dividend. It’s their way of saying, ‘Hey, instead of keeping all our profits, we’re going to give some back to our shareholders, and make ourselves attractive to new investors.’ That’s called a dividend – a little cash payment you get just for holding the share. If a company pays a $0.50 dividend per share, twice a year, and you own 100 shares, that’s $50 paid every six months.
Not all companies pay dividends. Some valuable, growing companies (especially tech companies) keep the money they make to fuel faster growth. That’s not necessarily a bad thing; it means they’re reinvesting to build the company and (hopefully) boost the share price long-term. A share that doesn’t have a dividend paid on it is called a capital growth share.
When the dividends are paid, you can choose to receive those dividends into a bank account or opt for a dividend reinvestment plan (dRP), which means those funds are automatically reinvested into more shares!
The question for you is: when choosing how to invest for your children, should you invest in a capital growth share or a share that pays dividends?
The answer is up to you. You can build serious wealth from share prices going up over time, but you won’t make any money from one year to the next in dividend payouts. Some investors prefer dividend-paying shares for a bit of steady income, as they want to reinvest it and grow the amount of shares they own. There’s no right or wrong, just preferences and calculated risks.
Edited extract from How to Raise Rich Kids by Sarah Megginson ($41.99, Pantera Press)
