Ask Paul: How can I invest for my 10-day-old grandson?

Dear Paul,

Finally I have a grandchild! He is 10 days old and will probably be the one and only. 

I want to set up an account that I will pay $100 a week into.

What is your recommendation? I was thinking maybe Vanguard. 

He won't have access until his 21st birthday as I want this to help him get into the property market when he is older. 

I have been saving $100 a week since I knew about the pregnancy, so I have $4100 to start with, but can easily add more to take it up to $5000. - Michelle

You have me chuckling, Michelle. Your enthusiasm and joy about your grandson just radiates out of your words.

My wife, Vicki, was also hanging out for grandkids, a gorgeous little girl arrived and then three other granddaughters in pretty quick succession from our son and older daughter.

My deadline for this issue came up during our January holiday, with our kids and grandkids.

Vicki is currently cuddled up on a very wet day at the beach with three-year-old Isabel, watching a kid's movie. They look very happy. You will get so much pleasure and have so much fun with your grandson.

I also love your enthusiasm to not only be part of your grandson's life but to be thinking of his financial future.

In my 40-plus years of answering money questions, you get my highest award.

I've had plenty of questions about investing for kids and grandkids, but never heard from anyone who started saving $100 a week and building up $4100 from first hearing about the pregnancy. Good on you.

Let's pause for a moment and look at the bigger picture. I agree with the idea of not transferring control of the money until he is 21.

But this is really in your hands. The best way to invest for him is in your name as 'trustee for' your grandson. As trustee you can pass on control of the investment when you choose.

Kids pay very high rates of tax on 'unearned income'. You will pay tax on investment earnings, but this will be pretty minimal on growth-type investments.

A further benefit of being his trustee is that when you do change the investment into his name, there will be no capital gains tax as he will have always been the 'nominated beneficiary' of the money.

Some may wonder what $100 a week will become in 21 years.

$100 a week, or $5200 a year, is a very generous amount to be putting aside. And the outcome, based on historical returns, is a very significant sum. Inflation devalues our money, so I have used a projection of a 4.5%pa return above inflation on the money you invest for him.

This is a conservative return on growth investments. It is historically sound as a reasonable return in excess of inflation. In other words, the number

I am about to show you is the projected value of your $4100, plus $100 a week, over 21 years.

Power of compounding

This may shock many readers, but it simply shows the power of regular investment and compound returns.

The projected value in 21 years, in today's purchasing power, is $295,000. What is really important here is time and compound returns. If you invested $10 a week, you are projected to have $27,500 in 21 years. My old favourite of just $1 a day sees a projected balance of $19,000.

And here is a tip for all of us. If at age 18 we, or someone we know, invested $1 a day until 65, the projected balance is about $175,000 in today's spending power.

Regular investment is a key rule of wealth creation. Add 4.5% a year to this and we then see one of the few true miracles of money - compound returns.

Invest in growth assets

Next, though, we'd better turn to how we achieve 4.5% above inflation. Pretty obviously, bank accounts will not cut it. Nor will a term deposit, even at today's attractive rates of around 5%. Interest earned has no tax benefits and inflation at today's rate is absorbing most of, or more than, your after-tax return.

So, we need to turn to growth assets, property, shares, infrastructure and so on. These are not easy to buy with $1 a week or $100 a week. So, an investment as you suggest, in a super low-cost growth fund such as Vanguard, is a great idea.

Another one, which we use for our grandkids, is InvestSMART's Fundlater.

All readers should note that I am highly biased, because I am a shareholder in, and chair of, InvestSMART. We chose the InvestSMART ethical fund, which, to be quite frank, is no better or no worse than the many good ethical funds available to you. But I really like the ability to start with $4000 and then InvestSMART adds $6000, giving our grandkids a starting investment of $10,000.

You don't pay interest on the $6000, but there is a $25 monthly account fee. You pay off the $6000 in 20 monthly repayments of $300.

How you invest your money is your call, Michelle. Vanguard, BlackRock or any low-cost fund is a terrific solution. InvestSMART simply adds gearing to the investment process.

Most importantly, enjoy your new grandchild. Money is very secondary to health and a happy life.

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