A common practice for new parents is to set aside a sum of cash for their children at birth with the idea of putting this amount towards their first car, school fees, or even first overseas trip. Stuffing cash under a mattress, filling up piggy banks, or opening a savings account with a special interest rate are popular ways parents save for their kids. While all good strategies in practice, we’ve outlined a few important things to consider that could impact the amount you end up with, and how to maximise it.
Time Value of Money
The Time Value of Money (TVM) is a concept taught in many finance101 courses around the world. This concept explains how a dollar in your hand today is worth more than the value of that same dollar in one years time. Seasoned investors know this, which is why they prefer to receive money today and put it to work immediately by buying stocks or real estate, rather than waiting to receive the same amount of money in the future i.e., through a savings account.
Source: Investopedia | Time Value of Money Explained
Is your head spinning yet? Don’t be alarmed! I’ll try my best to breakdown in simple terms the two ideas which behind the Time Value of Money concept.
Earning potential – a sum of money will only grow over time if you either invest it or save it (although history shows that over the long term stocks and shares generally outperform returns from interest earned via a savings account). If you do not invest it, you will have lost an opportunity to either earn passive income (via dividends) from that sum or have it experience capital growth (e.g., purchase a share for $10, it increases to $25, you’ve made $15 capital growth).
Source: Strategic CFO | Opportunity Costs In Your Decision Making
Inflation – the concept that a currency’s purchasing power declines over time due to the rising cost of goods and services, meaning that the relative value of your dollar is constantly being eroded. In other words, what AUD$1 can buy you today will buy less of that same thing tomorrow.
To help illustrate these ideas further let’s look at two very basic scenarios facing new parents who are interested in saving for their children’s future:
Option 1: Saving $1,000 for your child today in a bank account paying 2.5% interest
Option 2: Putting aside $1,000 in cash under your mattress
Money deposited into a savings account will have the capacity to earn interest over time. If you keep the interest earned in the same account, thus adding to the original principal, interest will then be earned on that interest. Earning interest on interest is a phenomenon known as compounding interest.
If left untouched, a savings account paying 2.5% interest every year will grow to $1,485 by the time your child turns 16. This represents a $485 gain over the original thousand dollars you had sitting under your mattress!
A few points about inflation and opportunity cost
Understandably, new investors are torn between two frame of minds; positive investment returns can be very rewarding, but it is also reassuring knowing your funds are secure in a bank account.
However, you should take note of the interest rate being paid on your savings, and especially if it is high enough to outpace the expected inflation. In our example we didn’t account for the effect of inflation, which actually detracts from any amount of money generated by an investment or savings. If you deposit cash in a bank account paying 2.5% interest but the inflation rate in your country is 1.5%, then over time you really only earn 1% interest (2.5% savings account rate – 1.5% inflation rate = 1% real return). Inflation is the silent killer to our hard earned cash!
Another consideration is the opportunity cost of leaving your $1,000 in a bank account over that period. The opportunity cost is the inability to take advantage of other, potentially higher return, investment options because you have decided to tie your savings up in a bank.
How Itrust Invest can help you
The bottom line is you don’t have to be at the mercy of inflation and opportunity cost.
The philosophy behind the experienced funds management team at Itrust Invest is to make available its expertise to parents and guardians who are looking to provide a head start on their child’s financial future.
Source: The Australian | Investing For Children Delivers Them A World Of Opportunity
An Itrust account is a simple way to start investing in quality investment options providing attractive growth opportunities over the long term, with only a $10 minimum investment amount. The investment funds available on the Itrust platform have been selected with a long term horizon in mind, providing opportunity for you to realise financial returns greater than a savings account.
Consider joining the Itrust Invest community today and start to make a real difference to the future of your loved ones.
If you’d like to know more then speak to the team via the live chat below, give us a call on 1300 811 119 or email us at email@example.com – we’d love to hear from you.
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Disclaimer: in preparing this blog we have not considered your personal investment objectives, financial situation or needs. Instead, this blog contains general advice and has been prepared for informational purposes only. It is not intended as financial product advice or a recommendation in relation to any investments or securities. Terms apply when using the platform provided by Itrust Investment Fund, and it is important you read the PDS and key documents before deciding if any of our offerings are right for you.