The basics of investing for kids (and grandkids)

Investing for kids has come a long way since the days of sending kids off to school with a few coins in a bank passbook. And not just because regulators decided the ethics of using sophisticated marketing tactics to lure children into sticking with a bank account was decidedly questionable and disturbingly effective… (I’m sure I’m not the only one out there who still had the same bank account as I had at five years old until my early 30s).

Better technology, better financial education and better access hasn’t just meant that there are more investors out there, it’s also meant more demand for products to create portfolios for children that can help set them up later. It’s also a fantastic way of helping them learn financial literacy, if you get them involved too.

There’s plenty of options out there, but it’s not necessarily a set and forget activity. To that end, I spoke to Peter Nevill from Viola Private Wealth and Arian Neiron from VanEck for the ins and outs of investing for kids.

The portfolio structure

There are a variety of ways you can invest for kids, but you need to bear two things in mind:

1. Kids under 18 can’t legally own shares (meaning you need to hold them yourself or in a specific structure).
2. Any unearned income (dividends, interest, capital gains) over $416 a year will require you to lodge a tax-return for your child if the shares are in their name in a trust structure or similar. (Read more at the ATO)

According to Nevill, these are some options to consider:

• In the child’s name with the parent as a signatory. This option avoids a capital gains tax event down the track because there is no change of ‘ownership’ but you do need to be conscious of income earned on the portfolio and the potential need to lodge a tax return for your child.
• Informal trust where the parent holds the investment on behalf of their child and transfers it to the child at 18 years old. Any income and capital gains are assessable to the parent. The transfer at 18 years old can result in capital gains tax implications.
• Family Trust: a flow-through vehicle allowing the streaming of income and capital gains to beneficiaries in a tax-effective manner. It can be expensive to set up but useful when the investment balance is material (or if the structure already exists so you are just adding the child to it). Nevill notes these can be “brilliant for flexibility, control, and asset protection”.
• Investment bonds: “Think of these as a tax-paid wrapper. Invest within and the provider pays tax at 30%, and after 10 years, you can withdraw the money ‘tax-free’. The child can also be nominated as the future beneficiary. Be mindful, there are tax penalties if you need to withdraw the money early, so think of it as illiquid.”
• Superannuation: it’s an existing structure and tax-effective, but bear in mind your child can’t access it until retirement, so if you want to help them earlier, you’ll need to consider other options.

One of the simplest and most common ways people access is the informal trust structure, which many trading platforms offer these days. For example, Commsec, Nabtrade and Selfwealth offer directions on how to use their platforms for minor accounts. You can also find businesses like Stockspot, which use an informal trust system for minors and do the investing on your behalf.

Nevill suggests that if you go for the approach of an informal trust, it is simplest to put the account in the name of the parent with the lowest marginal tax rate, given any income will need to be factored into their tax return.

What should the portfolio look like?

Just as when you invest for yourself, you need to ask yourself a few questions that will help you structure the portfolio.

1. What goals do you have for this investment for your child?
2. What is the investment timeframe and how old is your child now?
3. What you can afford to contribute to the portfolio?

For example, if your child is 15 and you want them to use the money to buy a car in three years, putting regular contributions into a term deposit or a high-interest savings account might be more effective than looking at an investment portfolio.

By contrast, if your child is five and your focus is to build as big a pool as possible for dreams like a home deposit, university costs, or other lifestyle needs your child might have, you might be taking a more aggressive investment approach.

“For young children the focus would be on long-term, high-growth cost effective opportunities that perform well through the economic cycle,” says Neiron.

He advocates a diversified portfolio that incorporates quality international equities from developed countries, Australian equities and large and mid-cap stocks from emerging markets like China, South Korea and India.

Nevill suggests the following asset allocations could be valuable to consider – if you start young, you can adjust over time.

What to buy for your kids

There are many approaches you can take. Some like to buy direct shares for their children, while others might look at ETFs, LICs and managed funds.

Both Nevill and Neiron suggest passive investments are a great, simple way to start out, offering you a quick diversified hit (and minimising the amount of effort you need to take to monitor your child’s investments).

Think ETFs tracking the ASX 200, MSCI Developed Markets, MSCI Emerging Markets as a starting point for research.

As a side note, I’ve invested for my own children in ETFs – I’d rather take the pressure off making the right stock choices (or having made wrong ones), and I know there are a few other members of the Livewire team who have done the same for their kids.

The next thing Neiron suggests investors focus on is quality. He reminds investors of the lessons from Benjamin Graham.

“Quality companies demonstrate resilience by falling less in a downturn and recovering to previous highs quicker than other companies. These companies also tend to capture a fair amount of the upside in bull runs,” he says.

If you want to spread a bit beyond the basics, Neiron’s top growth pick is quality global small caps, through an ETF like VanEck MSCI International Small Companies Quality ETF (ASX: QSML).

“This is due to the “size effect”, which has found that small stocks tend to generate higher returns over the long term compared to large stocks,” Neiron says.

If you start considering direct shares, Neiron encourages investors to start with high-quality sensible stocks, but also want to consider stocks that your children are personally interested in – particularly if they are older – like Roblox (NASDAQ: RBLX), Hasbro (NYSE: HAS), Disney (NYSE: DIS) or Nintendo (TYO: 7974)– to encourage their own engagement with investing.

How much do you need to invest

What amount you need to invest for your children can feel like a loaded question. How long is a piece of string after all?

“Whether it’s $5, $50 or $500 a month, don’t let perfect be the enemy of good,” says Nevill, adding, “you are planting a tree that will shade your offspring in the future.”

Any amount, at any point in time, is going to be helpful one day – and you are investing over a long time frame for the most part.

Remember the power of compounding can make little amounts really pay off too – and in fact, generate better returns than lump sums at various ad hoc points in time. It might allow investing to be a more manageable task too.

Nevill shares the below example to show how a portfolio can grow, it assumes a net return of 7% pa and dividends reinvested.

When to start

“The best time to start investing was usually 15 years ago, the next best time is now… and your children/grandchildren will thank you. And if they don’t?... well, maybe you deserve a trip to Europe?” says Nevill.

In short, you’re never too late to start investing – and it’s a great way to make a meaningful financial difference to your kids or grandkids down the track.

Have you invested for your kids or grandkids? Let us know your approach in the comments.