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By Sonia du Plessis *
One of the biggest worries for parents, especially in South Africa, is about what future they’re leaving for their children. Raising a family is a huge responsibility that only grows larger when you start thinking about how they’ll cope and how you could possibly help ease that journey a little.
Proper planning will help you get part of the way there, but nothing beats having a healthy pile of savings to get them started in life.
Even if you’re not able to offer them a future as a trust fund baby with no financial cares in the world, you can still reduce the burden by being diligent and financially savvy.
I want to emphasise the financially savvy part because this doesn’t require any special skills or training. But you can get a head start by doing one simple thing: don’t use a money market account for these savings.
Why money market accounts don’t make sense
A money market account is a popular destination for savings by investors looking for a safe destination for their savings. According to the Association of Savings and Investments SA, savers put R5 billion into money market funds in the 12 months to the end of September 2022, compared to R2 billion that flowed to SA equity funds. Globally there is an amount of $5.18 trillion sitting in money market funds at the end of 2022 (according to data from Ninety One). This is mainly due to market uncertainty.
Despite the popularity of money market funds, I don’t believe they are the right instrument to use when saving for your kids’ future, because you’ll be losing out on potential growth in other investment vehicles.
Just have a look at the projected returns over 20 years in a money market account (offering 5% annual returns) compared to the long-term average return in equity markets of 13%.
If we assume that you put away R500 a month, with an annual premium increase of 10%, for a period of 20 years – the equity investment will grow to just over R1 million compared to just over R500 000 in the money market account. If you consider that such a long investment time frame lets you recover from market dips, then the risk inherent in equities is well worth the 2x return you get over the ‘safer’ money market.
The graph also illustrates inflation- and clearly shows how money market won’t keep up with inflation. In a nutshell you are not getting any real growth in a money market investment.
Rather use a two-pronged approach
What I suggest to clients is to rather adopt a two-pronged savings strategy that leverages the best of two very useful investment types.
The first of these is the tax-free savings account (TFSA) that allows you to save into approved funds that offer you low, medium or high-risk equity market exposure. Best of all, though, you’re exempt from capital gains, as well as dividend and interest taxes on these funds, and these are usually low-fee accounts that allow you to get the maximum benefit from your savings.
You’re allowed to contribute a maximum of R36,000 a year (in single or staggered payments, or a monthly sum of R3,000) up to a lifetime limit of R500 000.
I always suggest that parents start with a TFSA, and that they look at using aggressive growth funds – typically equities with big growth potential. This should give you the best chance of growing your savings, without having to worry about taxes and high costs eating into your gains.
You can use these savings, for example, to pay for big future expenses like school or university tuition costs, a healthy deposit on a house, or buying a car.
Once you’ve developed this savings habit and have a bit more disposable income, I then suggest that you make use of unit trusts to build up a second pool of savings. With so many unit trusts to choose from, you can literally structure the savings to deliver maximum growth with minimal risk – otherwise known as diversification.
Other common pitfalls to avoid
One of the biggest investments you can make into your kids’ future is to make sure they appreciate and understand the value of money. Not simply so that they can gather worldly possessions, but rather to enrich their lives and those around them.
This starts with engaging them in conversations about the value of money and the lessons that you’ve learned.
One mistake you definitely want to avoid making is not mentioning a testamentary trust in your Will. Under-age children in South Africa cannot inherit any assets, so failing to include this in your Will means their inheritance will be governed by the Guardians Fund.
Another error of judgement that some parents make, is to dip into their children’s saving fund with the plan to repay it. There might be extreme cases where this can be justified, but this is seldom a wise move. Rather look to some short-term measures so that you don’t ruin their long-term future.
Also, open a bank account for them, but don’t give them control too early because they could well spend your hard-earned savings. In fact, you should involve them as much as you can in managing their account and the savings that you’re putting away for them.
Lastly, tell their oh-so-proud grandparents to forgo birthday gifts and rather give them money that they can add to their savings pool.
By instilling these money habits early, you’re giving your child the best possible chance of having a healthy relationship with money.
* Sonia du Plessis, CFP®, is Head of Brenthurst Wealth Stellenbosch.
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