Saving vs Investing for your child

Another thing you need to think about when setting money aside for your children’s future is whether to save or invest. There’s no easy way to decide this as it really comes down to your personal preferences but there are things you should think about such as your attitude to risk, the age of your child and the timeframe you’re putting money aside for (the last two are obviously related).

For the avoidance of doubt, in this post, when we refer to savings we mean putting money in an account (usually with a bank or building society) that pays a guaranteed interest rate. On the other hand, investing is when you put your money into shares or other financial instruments that do not guarantee a fixed rate of growth and whose value can go down as well as up.

How to decide whether to save or invest

Over long time periods, investing in the stock market usually outperforms saving in a bank account or savings account (but there’s no guarantee). So the younger the child is, the more likely that investing will outperform saving.

On the other hand, if you only have a short timeframe (let’s say for example your child is 17 already and they’ll need the money for uni fees next year), then the volatility (or unpredictability) of the stock market may mean it’s more sensible to save rather than invest. A general rule is you should not invest your money if you’re going to need it in less than 3 years (for example your child is going to use it to buy a house at 18 and they’re currently 16 years old).

Let’s take a look at a few examples to illustrate this. Firstly, let’s look at the performance of the MSCI All Countries World Index over the last 20 years (a good long-term indicator for the performance of the global stock market).

If you look at the performance from 2001 to 2020  you’ll see that it’s returned an average annual rate of 6.64% per year (excluding fees). That’s really high growth which we would all love to achieve every year. But if we look at it in more detail we can see that the index hasn’t actually grown by 6.64% a year. In some years it grew by more and some years it grew by less and even fell. The largest annual fall was in 2008 when it fell by nearly 42% that year and the largest annual gain was the year after (in 2009) when it increased by over 35%.

This is why investing should mostly be for the long term. If you had invested £10,000 for your 17 year old at the start 2008 to help with next year’s university fees, then that money pot would have been worth £5,815 just twelve months later (that same investment would be worth over £22k now for those who were investing for the long term and didn’t need to withdraw at end of 2008).

No one knows when these market drops will happen so usually the best way to manage them is to invest over a long time period and just ride them out as and when they happen. This is also the reason why as you get closer to the point that you need the money you should start moving it into less risky investments or maybe back into cash.

Difference between savings and investing

When you see a drop of 40% you might ask yourself, why would I take that risk and invest at all? The answer, as we said earlier, is simply because over the long term investments are much more likely to outperform savings and this outperformance makes a huge difference in how your money grows.

Today, the best junior cash ISA rate you can get in the market (according to an independent Hapi study) is the Coventry Building Society Junior ISA at 2.95%. Imagine you open an account with them today for your newborn and put £100 aside each month for them until they turn 18. At the age of 18 that account will have roughly £28,800 in it.

If instead that money was invested and grew at an average rate of 6.64% for the 18 years (i.e. the average rate of the MSCI All Countries World Index over the last 20 years), then the money would be worth over £42,000 on the child’s 18th birthday.

So while investing carries more risk with it (i.e. the value could go down or up), in our example the individual was able to make an extra £13.2k for their child over the 18 years. The other way of looking at it, is that instead of saving £100 per month, they would have only needed to save £68.50 a month to reach £28,800. That’s one extra Deliveroo per month for those that live in London, and considerably more if you live outside.

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Disclaimer:

When investing, your capital is at risk and may be going up as well as down which means you may be left with less than your initial investment. This article should not be read as personal financial advice.  Individual investors should make their own decisions or seek independent advice. Past performance isn’t an indicator of future performance.