It has been baby season at Nedgroup Investments. Having several of our team welcoming new bundles of joy into the world reminded me how exhilarating and terrifying being a new parent is. Not only do you yearn for an uninterrupted night’s sleep, but you also quickly realise how expensive looking after the new arrival(s) is going to be!
One of our new moms had twins so her thoughts must be doubly complex. This got me thinking about how parents could use their financial savvy to relieve some of this pressure. So, we did a little experiment.
Before I tell you about it, take a moment to think of the amount you need per month in today’s terms to be financially free - before tax, so equivalent to a salary. Please write down this number.
The little experiment that had very big results
Our experiment began with our new mom of twins, who was also involved in setting up our tax-free investment offering.
What if she and her husband invested R2,750 per month per child into a tax-free unit trust and left it there for a long time? A very long time.
• They would invest R33,000 per year (or the maximum annual amount allowed in a tax-free vehicle).
• The current life-time cap is R500 000 which they would reach in the child’s 15th year, but we have made the reasonable assumption that government will increase this cap over time in line with global best practice.
• We assume our new parents continue to invest until their children turn 18 - by which time they will have invested about R600,000 per child.
• This is a long-term investment, so our new parents decide to invest 100% in growth assets, predominantly South African and Global Equities.
• Looking back over the past century of returns from similar growth assets, a reasonable expectation from the investment would be a return of about 7% above inflation. Importantly, these annual returns will vary enormously over the short and medium term - with some terrifying years where the portfolio could fall as much 50% - but over the long-term this expectation is reasonable and the volatility acceptable.
Next, comes the key moment ...
At the twins 18th celebration party, our not so young and now-greying parents make a life-changing decision. Instead of giving their teenagers the keys to a BMW X5 (which would be entirely possible with the balance they had accumulated), they announce that their gift is a comfortable retirement!
Imagine starting your working life, confident that you have no significant need for extra savings to retire well. That you could largely use your earnings to enjoy life and its experiences and that any amounts you could or wanted to invest would be a bonus. Well, in our experiment, our two parents made this possible for their children.
How? Amazingly, by investing a relatively small amount early, not withdrawing and instead compounding over a long period of time, by the time the twins reach retirement at 65, the balance would have grown in today’s money to over R20 million.
This means the retiree twins could each withdraw R130,000 per month in today’s terms and the money would last until they were 100. Current life expectancies are in the mid 80’s but we expect life expectancies to continue to increase with medical breakthroughs.
As a further bonus this amount would be tax-free, so the equivalent taxable salary or annuity is a monthly amount of more than R200,000!
How does that compare to the number you wrote down?
This is a fantastic example of three fundamental concepts of successful investing:
1. The magic of compounding, especially over very long periods
2. The importance of investing sufficiently in growth assets that earn returns well above inflation (and not being too conservative or distracted by short-term volatility), and
3. Ensuring that taxes and costs do not erode your net return.
The point of this story is not to encourage a new generation of Trust Fund Children – it’s simply to illustrate how profound the effects of long-term saving can be, and hopefully encourage you to open a tax-free debit order for your children...today.