Investing for your children
How can you invest for your children from an early age?
Great question! This is precisely the question I asked myself when my son was born.
The wrong answer
Buy a studio (in France, for example) and give my son/daughter the bare ownership. Finance it with a 20-year mortgage and pay the mortgage back by renting it out. This results in a slightly negative yearly cash flow. Then, after 20 years, sell it, buy a bigger apartment with the capital, and start again. In the future, your child will have his own comfortable home.
Why is this the wrong answer? Because you can achieve the same result with the same monthly savings but:
with much less effort
with less risk
without closing off avenues for any other investments
Finally, mixing pleasure and investment often leads you to overpay, and therefore increases the monthly effort required for the same result.
The right answer
Invest small & regular amounts in a low-cost, low-tax diversified stock ETF.
Invest small & consistently
We all want to give as much as we can to our children.
But the key to this very long-term investment is consistency: start as early as possible, and continue without interruption. If you contribute a lot and restrict yourself too much, you run the risk of stopping.
So, contribute a monthly amount that you'll barely notice: whether it's 100 euros / francs or 1000, the impact over the very long term is huge.
If you contribute from birth and invest well, by the time he's 40, he'll have in today's money about:
150k - for a monthly contribution of 100
and 1.5 million - for a contribution of 1,000
This corresponds to an average annual return net of inflation/fees/taxes of 5% (9% - 2% inflation - 1% fees - 1% tax).
In a diversified stock ETF
It's easy to invest in diversified stocks via an ETF. The highest diversification is with the global economy.
Global indices have only been around for 30 years, but American indices (S&P 500 or equivalent), which have been around for 150 years, show average annual returns gross of inflation of 9-10%, and returns net of inflation of around 7%.. What's interesting is their relative stability over long periods: systematically between 4 and 9% over any 40-year period.
Warning: don't restrict yourself to Europe, or worse, France or Switzerland, as yields are historically much lower. The only three rational choices are: the US, all developed countries, or the whole world.
Low cost, low tax
So, which ETF should you invest in? An "All-World" ETF (world), a "World" ETF (developed countries only) or a "S&P 500" ETF (US), with a maximum annual cost (TER) of 0.3%, and ideally closer to 0.1%.
Choose a single ETF: this avoids hesitations that may delay or even make up an excuse for not investing or interrupting the investment. No monthly headache about which ETF to invest in. No headache either about rebalancing. A single ETF is also cheaper because you'll be making fewer transactions and therefore incur lower transaction costs.
Stick to an "accumulating" ETF: you don't have to manually reinvest gains as you would with a "distributing" ETF. Because if you forget about reinvesting, your return will be lower.
But which ETF precisely? That will depend on which ETFs are available in low-cost, low-tax accounts:
Low-cost: aim for a maximum total cost of 1%. Total cost includes the TER of the ETF above, and also the costs of the investment account. The investment account may include entry costs (a % of the amount invested, once only, amortized over the duration of the investment), transaction costs (a fixed amount for each buy or sell transaction), and finally annual management fees (a % of the amount in the portfolio).
This shouldn't go above a yearly 0.6%, and ideally be closer to 0.1%.Low tax: aim for a maximum tax burden of 1%. First, you need to consider the taxation of your gains (capital gains and/or dividends). Then, there may also be inheritance / gift taxes if you invest for your child in your own name, which you should try to avoid. All this depends on where you live and the type of investment account you have.
The practical answer therefore differs depending on the country of tax residence.
>> SWITZERLAND: How to invest for your children from an early age
>> FRANCE: How to invest for your children from an early age
Why is it better than the apartment?
First, you really need to combine all the right conditions to hope for that much with your apartment. Why is that?
A €150k studio fully financed with a 2% mortgage rate over 20 years will require €809 in monthly payments.
You'll get a maximum net yield of 4.5% (rents - tenant vacancies - homeowners fees - taxes on property income - property taxes - repairs). This corresponds to an initial net amount of €562, or an initial savings effort of €250. The rent increases a little with inflation, so assume an average savings effort of €200 over the period.
You do the same thing again after 20 years and, if all the stars are aligned, you'll generate €300,000 net of inflation after 40 years, with a €200 monthly savings effort.
Less effort
To find the perfect property with a net yield of 4.5%, you're going to have to spend some time. Twice.
Then negotiate the loans.
Then do some repairs yourself.
Then find good tenants. Then manage rotations. Even more rotations if you rent on a seasonal basis to increase yield.
Then file tax returns.
Then make repairs.
Then resell the two apartments at a good price.
Instead of:
Opening an account and spend 1 hour setting up recurring operations
Depending on the case, but not always, making an annual currency conversion.
Depending on the case, but not always, making your tax returns more complex because of new investment gains.
Less risk
With a physical asset, there are always unforeseen circumstances, especially over 40 years. And the pleasant surprises are rare.
Repairs, tax changes, non-paying tenants, regulatory restrictions on rent levels - all these can reduce profitability.
With a very long-term diversified stock investment, there are of course a lot of fluctuations along the way, with -50% from one year to the next, but historically, the return net of inflation has consistently been between 4% and 9% over any 40-year period.
Without closing off any avenues
If you take out a loan for the apartment, you increase your debt, and this limits the debt you can use for other potential investments (or the purchase of a main residence).
And even if gifting the bare ownership of a studio in France doesn't usually generate any gift taxes, you'll be using up a tax deduction, which could generate additional taxes for your future gifts.
If you're a Swiss resident, this point doesn't usually apply to you, unless you want to bequeath other French assets.
Practice
To find out how to invest in your situation, take a look at my practical articles based on your country of residence:
>> SWITZERLAND: How to invest for your children from an early age
>> FRANCE: How to invest for your children from an early age
About the author
Hello, you can call me Margot.
I'm a French expatriate living in Switzerland. I've been investing for 15 years.
With assets in the low millions, I'll probably never have a family office, so I have to stay in the driving seat. How can I grow my assets further and pass them on to my children?
AskMargot is my testimonial, that of a peer, to go further in wealth management.
You'll find unique content, more advanced than what you'll find on beginner investment blogs or in the wealth reports of French or Swiss asset managers.
Don't hesitate to contact me if you'd like to discuss your wealth strategy with a peer.
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