One of the big questions when considering smart investments choices for kids is: bonds vs direct investments?
My husband and I knew from the moment we learned we were pregnant that we wanted to build a cash nest egg for our baby.
We wanted to be able to gift them a significant lump sum that they could use for whatever they wanted. With any luck, it’d be a house deposit, or a great tertiary education experience – including a gap yah – or perhaps world travel or living overseas.
In an ideal situation, we’d teach him how to invest and encourage him to add his own pocket money to the fund, especially once he saw first hand how little and regular contributions can turn molehills into mountains.
But that’s thinking very far ahead. The first questions were around where to invest, how much to put away as well as how to do it most effectively for tax benefits (both us > income and capital gains and him > potential inheritance tax implications).
And so it began.
A numbers game.
How much is a suitable amount to gift a child for their journey into adulthood? What’s a reasonable amount to set them up with, knowing that they’ll be in the prime time of their life for frivolous spending (and rightly so)?
Do you offer it as a surprise for their 18th birthday? Or do you engage them in the process as they grow, so they know and look forward to receiving the money? Do you provide it conditionally (i.e. it can only be used for this, this or this) or dump them with the details of their new bank account and hope that everything you’ve taught them comes into play?
I think that there’s no right answer for the amount they acquire, or the logistics surrounding their receiving of it. Every family is different. But what can help peel back the possibilities is reverse engineering your circumstances to show what’s realistic for you.
We sat down and talked about how much we’d really like to give our child as a cash lump sum. The answer, for most parents is obviously the world, but that doesn’t translate to reality for two young people.
Instead, for us, anywhere from a $100k to $150k felt like enough to give him a great start, but not too much that he would forever behave like a Trump-esque asshole splashing the cash.
With our current budget – including the added costs of raising this new family member (more here on budgeting for a baby), we worked out that we could reasonably save $3000 a year to be invested.
If you have more than one child, you might work out the overall amount you can afford to save, and then divvy it up by number of children. Note: You probably won’t have separate investment accounts for each child, but a rough mental idea of how much ownership each child has to that amount.
That $3000 a year worked out to be $250 per month. And over 18 years, at a 7% return, turns into $107,685.34. That doesn’t account for tax, but we’ll dive into that a little more later. We figured that that was a base number, given we would likely have some months where we could add in a little more, or contribute lump sums in the way of any birthday money he might receive*.
*I saw on a fridge at someone’s house that they were asking for $5 instead of birthday presents for their childs’ 5th birthday. It was going to go to his spending fund, so he could buy a big-ticket item he really wanted. It’s unconventional but I absolutely love this idea. It’s affordable for attendees, it reduces gift clutter and it allows the child to actively save and spend their money. I think that understanding this process for kids (and starting them early on it) is invaluable.
Bond, explain bond?
So, enter stage left: bonds.
Bonds are managed financial products sold by individual companies, or the government. They are widely considered to be a less risky asset than other high-growth investments (think shares, although I debate this) or property (this I do not debate). They’re also known as “defensive assets”. Growth assets are typically much more volatile (wacky highs and lows in the short-term, sturdy over a substantial period of time). I haven’t dabbled in bonds, like… ever, so I really had no experience with them and didn’t feel comfortable talking to them.
But hey, they might be a good option to hold onto the little laddies cash, right?
Not for us, and here’s why.
The “tax-paid” branding isn’t quite right.
The main appeal of investing in bonds has long been that the income tax rate on them is effectively capped at 30% (the corporate rate). So, if you’re subject to a personal marginal tax rate greater than 30% (as many of us are), they look – from the just-Windexed exterior – to be a good option at reducing your tax bill on their value.
Plus, as many friendly society and government bond kick-back salesfolk would reiterate, the net earnings of the investment are not subject to any further tax implications once you’ve held them for 10 years.
Any earnings on them are taxed within the fund, meaning that the tax you ever pay is no greater than that of the corporate rate.
But here’s the thing – tax rate payable isn’t the only thing to look for in an investment structure. Entitlement reductions matter too. And for “tax-paid” bonds, capital gains tax discounts don’t apply, meaning you can’t utilise any of your entitlements for a lower overall after-tax return rate.
That’s ultimately less cash in your pocket, compared to an investment where say, only 50% of the capital gains on a share is subject to income tax (as is the case for shares owned in a personal name), or where imputation credits would give you a greater net return.
Uncle Sam is always knocking.
Unlike direct investments, where you can postpone paying CGT by holding on to the investment (selling at a time where you’ve set yourself up at a more tax-effective rate), and where management fees don’t eat into your net return (personal name assets don’t require management fee consideration), all gains seen by bond companies are subject to the company tax because investments have to be sold if the bond is exchanged. Even more boo-hoo-hoo, bonds have to pay this tax on your lovely capital gains every single year. *shakes fist*
This all adds up. In some cases (I think in many cases), the growth will barely match inflation. As Dickhead Donald would say, that’s uge. Uge.
Conditions vs circumstances.
Think about conditions and circumstances as those mountain goats who are always logger-heading like their masculinity depends on it.
Conditions and circumstances are very rarely in sync because the very nature of them oppose one another. Conditions are concrete, and circumstances change – particularly over the timeframes that bonds take to appreciate.
That’s why 10 year plans are nice – but so laughable. When do we ever uphold plans and goals? And particularly when it comes to what our children do, is there really ever any guarantee?
Educational bonds (bonds sold under the premise that the earnings will be used to finance future education), are essentially teetering on the precarious ledge of our kids desires. What if little Jess, or teeny Mo decides university is the agenda of the devil and doesn’t want to join their cog in the wheel of capitalist grooming?
I’ll tell you what. 1. You have a badass kid socking it to the man, and 2. Your conditional tax refund is null and void.
Conditions, like those seen in many mainstream bond products just felt too limiting for us, and ultimately, although marketed nicely didn’t stack up in terms of return, perks or tax effectiveness. In the debate of bonds vs direct investments, slow and steady has won the race for us again. We’ll stick to what we know.
I wanted to add that this is my personal opinion on investment bond structures. They’re not my cup of tea but that’s not to say they don’t work for many. There are various different types of bonds, too – you can hold shares in investment bonds and some even offer Vanguard index funds within them. Please remember that this is only personal opinion and not personalised, professional financial advice.