With real estate prices absolutely soaring, and the average house price crashing through the $600k mark, the dream of our kids one day owning their own homes is fast evaporating. But our kids are young, very young, and they have that magic ingredient called ‘time’ on their side. Here’s how we’re using time to buy our kids an apartment for just $25 a week.
Now, just to stop the naysayers in their tracks, our kids won’t own an apartment outright. They’ll be sharing ownership with a bank of course. But they will own the apartment in their own names. And they’ll only be 21 years old.
Yes, they’ll have a mortgage to pay. But they’ll also be earning every cent in capital gain the apartment makes. And if you buy well, and structure this plan properly (that’s another way of saying, ‘with a bit of luck’), the apartment could be self-sustaining through rent.
Right, now that we’ve got that part out of the way, let’s show you the numbers.
Our plan to buy our kids an apartment for just $25 a week
The way this works is we invest in their money in the stock market. There’s nothing scary about this part. We buy a passive ‘managed fund’ (sometimes called an ‘index tracker’), so we don’t need to know how the stock market works, or even what we’re investing in. The experts take care of everything for us. And, in fact, a computer takes care of it for the experts, so they don’t even need to know!
We also buy the managed fund through our bank. There’s no such thing is risk-free investing of course. But buying a ‘passive’ fund, through your bank, is getting pretty close.
A passive fund is simply one that buys a broad range of shares, and holds them for the long term. These funds show strong and consistent returns over the long term. They also tend to have lower fees, so a win-win.
Super-important point number 1: Only buy a broad ‘growth’ fund
Forget any ‘moderate’ type fund that keeps a bunch of cash on term deposits. That won’t make your kids money. We’re looking for funds that invest in what’s called ‘mid-cap’ stocks. These are smaller companies (still large, just not Apple huge) that tend to grow faster over time than the largest companies.
Also, don’t look at the New Zealand mid-cap fund, or even an Australian mid-cap fund. They’re just not broad enough. Something like a fund that invests in the S&P 400 mid-cap (that’s the top 400 medium-sized companies in the middle of the US index) is perfect.
Over time (this is a long time by the way, 20 years +), this type of fund will return something around 9 – 11% on average after fees and taxes.
Don’t take my word for it (don’t take my word for anything by the way, do your own research) but the US stock market returned 9.69% over the last 50 years. It’s done something similar over the last 100.
Our bank just happens to be ASB, and ASB just happen to have some of the best funds available. And no, I’m not trying to sell you one! ANZ also have some real high-growth funds. And ASB actually just invest your money through ‘Vanguard’, which is a huge global company that specialises in high-growth, passive index funds.
Over the last 5 years, the ASB growth fund has returned 10.21% after fees and taxes.
To buy this fund you need $2,000 to get started, and then just $25 per week after that. And that’s where our $25 a week comes from! Now I know you can afford $25 a week (although this adds up quick if you have 3 or more kids!). You may need to stop buying that large, triple mocha latte each day.
As for the 2 grand to get started. Well you’ll just have to scrabble and save to get that part.
Super-important point number 2: Time is your investment’s best friend
Now, here comes the mind-bending magic. There’s also a bit of maths involved, but we’ll show you how to get the result with an online calculator.
The magic is something called compound interest.
It’s actually really straightforward, it just sounds fancy. What it means is that each year your investment earns interest (eg 10.21%) on your savings, as well as earning interest on your interest.
The interest on your interest is almost nothing in the first year. In fact, years 1 through 5, it’s still just cents on the dollar. But, after year 8, and then especially through years 10-20, something really magical happens. Remember you’re earning interest on your interest every year. So by the time you get to year 10, you’re earning interest on 10 year’s worth of interest.
Here’s an example of compound interest if you had $100 earning 10% per year:
Investment returns on $100
Year 1 – $110 – So you made $10, big deal
Year 5 – $161.05 – Well, you made $10 a year, plus about $11 extra, meh
Year 10 – $259.37 – Hold the phone, you’ve made more than $15 a year
Year 20 – $672.75 – Break out the champers, you’ve made over $28 a year!
As you can see, the interest on your interest really kicks in after year 10. And the same 10% per year earns you almost triple in year 20 as it did in year 1.
Our estimated investment returns over 21 years
Things get even more exciting though, when you make regular contributions into your investment. Remember we’re only talking about $25 a week here (well, $50 for us as we have 2 kids). It’s not much to find each week, but it does add up over a year.
Also, remember we started with $2000, as the minimum investment. Here’s the numbers:
Original investment – $2000
Annual contribution – $2,600 (that’s $50 a fortnight for our 2 kids)
Average investment return – 10% per year
Return over 21 years – $181,207
I know right? If you don’t believe me, or you want to play around with the numbers, check out CalculatorSoup.com.
Super-important point number 3: Time is also your investment’s worst enemy
180 grand sounds pretty damn awesome. But the news isn’t quite that rosy.
Yes, your kid’s account should show that figure in it when they turn 21. But unfortunately inflation has nibbled away at the returns over time. So we need to account for this. And thankfully the handy calculator at CalculatorSoup.com can do this for us.
We’ve used a figure of 2.5% inflation per year. It’s a guess really. But New Zealand’s inflation has averaged around 2.7% over the last 15 years, so it’s a fair guess.
Inflation adjusted investment return
Inflation adjusted return over 21 years – $107,888.16
OK, so not quite as good as before, but I’m still going to say it, ‘Cha-ching!’
Super-important point number 4: Why an apartment?
This is a great question. There’s 3 major reasons why we think an apartment is the best buy for our kids in 21 years time from now.
- Apartments continue to look relatively cheap compared with housing in New Zealand.
- Apartments are generally considered a ‘safe’ investment that don’t grow that quickly. That’s perfect for us, because we want apartments to still be relatively cheap in 21 years time.
- As long as you run screaming from anything that’s leaky or needs earthquake strengthening, then apartments are relatively low maintenance. Perfect for first home buyers without much income.
- Central city apartments make amazing rental properties. They’re always in demand, typically rent to city-based workers, and command quite high rentals.
- My long term guess (note above where I recommend not taking my word for anything!) is that quality central apartments in New Zealand will outpace the stock market about 15 – 20 years from now.
My reasoning for number 5 above is that our insane appetite for housing is coming at the expense of building apartments. And more and more people keep moving to New Zealand and living in the cities. Where will these people live?
With central city house prices already topping well over $1 million, people can’t afford to live there now, let alone in 20 years from now! At some stage in the next 15 – 20 years, people will turn around and say, ‘gee, we really should have built more apartments.’ Good quality, affordable apartments will begin to look very, very attractive!
Super-important point number 5: Can a 20 year old really buy an apartment?
Before I answer that. Let’s at least look at what we could buy. Let’s assume that apartments grow at an inflation-adjusted rate of 5%. Currently you can get a nice 2 bedroom central city apartment in Wellington City for around $345,000. So 21 years from now that apartment will be worth around $960,000 (insane right!).
Our kids will have around $180,000 saved up. This is a little bit shy of the 20% deposit they’d need. So, we’ll need to top up their account a little. Or, we’ll need to add a little bit each year to the amount we save for them (ie add 2.5% to the amount we save each year).
And, let’s be realistic, they have no, or very little income. We’ll need to guarantee the loan in some way. Hopefully we’ve paid off our own mortgage over that time. We’ll then be able to use the equity in our home to guarantee the loan for them (banks love this by the way!).
You’ll need to set some ground rules here:
- Can they use the apartment’s equity to buy out your guarantee (this can be done using a simple deed of trust)?
- What happens if the rent doesn’t get paid?
- Who’s ultimately responsible for the apartment?
They’ll also have to make a decision about how to fund the mortgage, their choices are:
- They rent it out and keep it as an investment property
- They live in it together, and their ‘rental’ payments go to paying off the loan
- One of them lives in it, and they rent out the spare room
Although you might find it hard to imagine your kids living together(!), if this becomes their only realistic way of moving out of home, you might just find them getting along quite well.
So that’s our plan. Obviously there are a whole heap of assumptions in here. Not to mention calculations using my terrible maths. But you get the point. You need to save a little bit every week, you need a high-performing growth fund to invest in, and you need time. If you have those 3 ingredients right, you could very well set your children up for life.
You might also want to check out Five tips for improving your family’s financial health. Or check out the expert advice in our Family finances section.
