Education, a first car, getting married and a deposit for a house are just some of the daunting costs faced by the younger generation. Investing from an early age could be a great way to give your child or grandchild a head start towards some or all of these.
A Junior ISA remains a popular option with these life goals in mind. Family and friends can help build tax-efficient investments for a child with an allowance of £9,000 a year. Importantly, it has the same tax benefits as an adult ISA – there is no tax on profits or income.
Withdrawals are possible from age 18, so Junior ISAs could be a great way to put money to work for them, especially if you start soon after your child is born to maximise the time your investments have to grow.
The magic of compounding
Investments for children generally have time on their side, so taking on the risk and volatility of the stock market in pursuit of higher returns is worth considering. By doing so you stand to better harness what is known as ‘the miracle of compounding’, the gradual but potent effect of getting returns on your money and then returns on your returns.
For instance, say you have £1,000 and you earn a 5% annual investment return after charges. In the first year, you would grow your investment by £50, giving you a new value of £1,050. In year two, you would earn 5% on the larger balance of £1,050, which is £52.50—giving you a new balance of £1,102.50 at the end of the second year.
Thanks to the magical effect of compounding, growth can accelerate over time as you earn returns on increasingly larger amounts. In this example, after 30 years the original £1,000 would have grown to £4,322 without a penny added. Think of it as a ‘money snowball’ rolling down a hill accelerating your returns over time.
Making a profit consistently is sometimes easier said than done of course, and the value of investments can fall as well as rise, especially in the shorter term, and they don’t offer the security of cash. This means your choice of investments is very important. A really big loss can be hard, if not impossible, to recover from, which is why taking a sensible amount of risk to provide a slower but steadier return can be the best way to benefit from compounding while dealing with the unpredictability of stock markets.
Could you child become a JISA millionaire?
Fortunately, regular Junior ISA investing helps iron out the inevitable volatility of markets. By contributing either a lump sum or series of lump sums every year totalling up to £9,000, or a direct debit into the account for up to £750 a month, you buy more shares or units when prices become cheaper and fewer when they become more expensive. This is known as pound cost averaging, and it can be highly beneficial investment strategy in terms of controlling volatility, albeit it’s generally better to invest any amount of money at outset than spread it over time as you stand to compound returns on the whole amount for longer.
- Unfortunately, making your child a Junior ISA millionaire by age 18 is unlikely to be achievable. Assuming the current maximum of £9,000 is paid in each year, a somewhat unrealistic annual growth rate of 17.5% after charges is required to hit seven figures at that age.
- However, you could quite feasibly generate £1m for when your child is into adulthood, even if no contributions are made after age 18. For instance, an annual growth rate of 5.9% after charges would turn the £162,000 invested between birth and age 18 into just over a million by age 40.
- Achieving this feat before 30 is a taller order and would require growth to compound at 8.4%. However, it is not entirely out of the question. Global stock markets have produced an annual growth rate of 8.1% for UK investors over the past 30 years, albeit with plenty of bumps along the way – although performance is not a reliable guide to the future, and the returns from the past three decades may be atypical of what we can expect from a potentially less benign period for global stock markets in future years.
When it comes to investing with an adult ISA (Individual Savings Account), there are several strategies you could use to maximise your wealth.
Follow the link to find out more: Four habits of ISA millionaires
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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