Could parents use KiwiSaver as a method for rewarding children in the form of pocket money? Read on to see how one of our clients is not only successfully doing it but also teaching their children about the magic of compound interest.
Whether Albert Einstein ever actually said that compounding interest is the eighth wonder of the world is debatable. Regardless, the sentiment grows increasingly more and more true every day (see what I did there).
Compound interest is the effect of invested money receiving regular interest payments that are reinvested and allowed to grow.
For a simple example of this, let’s look at $100 invested at 10% per annum (a high interest rate but easy to calculate).
Day 1 – $100
1 year – $110
2 years – $121
5 years – $161
20 years – $739
So an investment of $100 has increased to over $700 in 20 years and will increase by another $73 the next year. We are almost at the point where we are doubling our initial investment every year, all thanks to compound interest. If you had simply left in the $100 and taken out the interest, you would have received $200 of interest and still only have your original $100.
It shouldn't come as a surprise that putting money aside for young children is therefore going to result in huge returns for their retirement. Let's look at an example of $1,000 of savings put into an investment fund for a newborn.
Let's assume the savings will average 10% return on this fund but let's take off 2% to allow for tax. So an 8% return over 65 years would mean a total savings of $178,000 upon retirement. While this isn't enough to retire on, it shows how $1,000 can change into a much larger amount given enough time.
There are 2 thing to really acknowledge here.
Leaving it until later in your child's life significantly reduces the amount saved. $1,000 given to a 20 year old - as opposed to a newborn - will mean ~$36,00 in the fund at retirement instead of $178,000.
If you can afford it, even a small regular deposit will grow your child's retirement savings. This is all thanks, again, to compound interest. Remember the initial deposit of $1,000 which became $178,000 at retirement. Well, if we add another $20 per week onto that for 65 years you have deposited a total of $63,400 into the fund however that fund has grown to $2,318,000 (based on the same 8% average growth). At this stage, we're talking serious money to retire on.
So, if pocket money is one of the methods you use to facilitate family-based child-slavery, then consider putting some of that money into KiwiSaver. Notice I say some of it. Children don't wash dishes on the promise of an easy retirement in 50 years time. You'll probably need to give your child some actual money too.
But it's a great opportunity to teach your children about interest. For this article, I have been using this compound interest calculator. Feel free to play with it. Here's an example that might encourage the savings bug.
Let's say your 10 year old child has $5,000 in their savings. You're putting $20 into that fund per week (in the calculator, I put $80 per month). The calculator is showing a total of $1,358,934 at retirement in 55 years. What does it show if they deposit one $20 note into that fund? Not multiple, just one note. The answer is $1,360,540. A difference of $1,606. $20 put into their fund today gives them $1,606 at retirement!
I know that pocket money put into a savings account or KiwiSaver will not thrill most children. I can hear parents screaming at the screen right now. But I do suggest taking the opportunity to show them what a little savings means for their retirement. The calculations haven't taken into account purchasing houses in their early adult life and all other sorts of life events that will affect their savings. The bottom line is, however, the sooner you can start putting money aside for your child's retirement, the easier it will be for them. All thanks to the magic of compound interest.
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