One of the most important reasons why people invest is to secure their kids’ future. For those of you with kids, nothing else is more important to you. But, it is important to you that you can maintain your lifestyle – also that your children and your wife can live comfortably. So, what you have are multiple goals. And these goals may seem like they compete with each other. But it doesn’t have to be that way….
Goals-based Investing
There is a new approach to investing that has been developing recently. It is known as goals-based investing. In some ways, it is a combination of the two approaches to risk management that I discussed in my previous article.
So, I discussed two methods. The “margin of safety” approach and the diversification method. With the margin of safety approach, you concentrate your investments in a few investments (maybe even one) that you know well. These will be investments in which you have significant expertise. You will also need a lot of time to manage them.
The diversification method involves investing in a large portfolio of different assets. You might invest in an index fund (which tracks the S&P 500 for example) and a government bond fund. You might also invest in international stocks and bonds. And you could include cash and gold as well.
Goals-based investing can include both or one of these methods. For example, you might have a diversified portfolio to ensure that you can live comfortably in retirement. But what if that is not enough?
The Aspirational Portfolio
Ashvin B. Chhabra has suggested an answer to this question. We all want to be able to retire comfortably. We would like to ensure we can do this without the risk that we will lose everything in the next economic collapse. But at the same time, we all aspire to be more than just comfortable.
We want our kids to be comfortable. Our wife too. We want to support them meet their goals. And perhaps secretly we aspire to great wealth. Or maybe just more wealth than it takes to be comfortable.
For this aspiration, Chhabra has suggested an Aspiration Portfolio. If you imagine your portfolio as a pyramid at the bottom you will have your emergency fund. This will be mainly cash and other “safe” assets to protect you if you lose your job. Or need to pay sudden medical bills.
Pyramid Investing
For example, in September 2016 I lost my job at the bank. Fortunately, I had a significant emergency portfolio. It contained cash, gold and insurance contracts. This portfolio sustained me for the nine months that I was out of work. Having an emergency portfolio is critical.
The next layer of this investment pyramid will be the standard diversified portfolio that I have written about extensively. You undoubtedly have read about it elsewhere. Depending on your situation, this will likely be invested in various proportions of stocks, bond, real estate and other alternative investments.
Most people will have some variant of these two layers.
Next is the Aspirational Portfolio (as called by Chhabla). This is the portfolio that contains those investments that if they fail, it will not impact your ability to look after yourself. You can further layer this portfolio to cover your additional goals. You will need to prioritize these goals.
Investing for your aspirations…
This is where you include the goals that you have for your children. Or maybe you wish to leave a significant amount of money to a charity when you pass on. Or perhaps you aspire to great wealth? You will need to categorize these goals in terms of risk. So, for example, the more important it is that you achieve the goal, the less risk you can take.
If you focus on stocks…
However, some elements may not so much as require “risk” as require “hard work and expertise”. The aspiration for great wealth need not be risky. But it does require time and focus. If you decide to focus on earning money from stocks then Warren Buffet’s method makes sense. Warren Buffet says that risk “comes from not knowing what you’re doing”.
So, if you decide that stocks are the investment for you then you will need to make sure that you have the skills that are required. Most people do not have these skills. Where do you get these skills? You get them from rigorous study. You also get them from your job.
… your job is probably the best source of the relevant skills.
In fact, your job is probably the best source of the relevant skills. For example, I learned how to invest by doing it for the bank. And the best part, I was doing it with the bank’s money! No risk for me! And in fact, I was being paid to do it.
However, in order to get a job investing for the bank I needed some understanding of investment. This I learned in school and by earning the Chartered Financial Analyst® (CFA) credential. This credential is the “…highest distinction in the investment management profession…”.
So, between learning the skills through study and learning on the job I am in a position where I can personally pursue building my Aspirational Portfolio.
What if you’re not an investment expert?
But what if you haven’t spent years studying and working for banks? Well maybe progressing through your job is the right path. One of my clients is a software developer working for a tech firm. He enjoys the work and is now a highly paid senior executive. He has no children but he aspires to build a large real estate portfolio.
Because he is so well paid, he has sufficient disposable income to invest in real estate. He actually invested in a housing construction project. This was a project to build eight houses. After they were constructed he then planned to sell them at a profit. Unfortunately, due to delays and increased costs he is just about breaking even.
However, this was his first attempt. While he has not made any money, he has learned a lot about real estate. Now as an expert in real estate I would have discouraged him from this investment. Construction projects are the most complex investments that you can get into with real estate. Property development is a high-risk investment. It’s not really the best place to start. I suspect that many people gravitate towards real estate investments because of the physical nature of it. You can go and visit your investment. You can touch the bricks and cement. It isn’t abstract like stocks and bonds.
Real estate can be really risky!
However, it can be as risky if not riskier than stocks. One aspect of a construction project is the fact that your money is locked in, sometimes for years. You have to trust many different parties to ensure that the project is completed. Various contractors, letting or sales agents, and surveyors. The market may turn against you before you can sell your development. Or you may have delays in construction. These delays can cost you thousands. This can destroy any profit you hoped to make or even wipe out your entire investment.
I normally suggest that people start with real estate funds. They work much like index funds. Once you get used to that maybe you can move on to slightly more complex investments.
But we all learn in our own ways. My client is happy with the way things have progressed. Do whatever works for you.
Leverage your disposable income…
The point of this story is that you can leverage income over and above what’s going into your pension. And use this income for your aspirations. If you have kids, then you can use it for securing their futures.
But what if you don’t have additional income from your job? Maybe you don’t have extra income but you definitely have skills. Find a way to leverage these skills to generate extra income. Then reinvest the income in this side business. This compounds your profits from your side business. The reinvestment in your business will enable it to grow. This growth will lead to improved profits in the future.
Learn something new…
One of my clients for example, decided to learn carpentry on the side. He has two children. He has a pension. But he needs a little something more to secure his kids’ future. He works for a financial services company. The work there is dull, mind-numbing and repetitive. His employers don’t care about him or his kids’ future.
So, he followed his passion. Working with his hands. Watching a product take shape in front of his eyes. And ultimately, delighting his customers with the results. Eventually this passion will eclipse the income from his job. And because he loves it, he will ultimately earn much more money from it. Kids’ future secured.
Try an online business…
And there are so many other options. You can try an online business (like I have). Find that intersection between your marketable skills and your passion. Create an expert blog or online consulting businesses. There are ways that you can turn the skills that you have learned throughout your career into a business. You can do this either online or offline.
Another possibility that is open to anyone is affiliate marketing. Affiliate marketing is where you sell products online for the manufacturers or software developers. You earn a commission for each sale. Many people have earned a significant second income from this kind of work. It also does not require a significant investment of either time or money once you are up and running.
Getting back to investment…
I do not want to get to far afield from investment. However, starting a business or investing significant disposable income should be considered as part of your overall investment strategy. Buying a house that you rent to people is an investment. It will have a return that you can calculate.
The options I have laid out above will form part of your aspirational portfolio. In these investments you will be an active investor in many cases. This is different to passively investing in an index fund. There is an ongoing debate concerning the value of passive versus active investing. You can invest in a fund where the fund manager actively invests your money. This means that he is constantly buying or selling stocks. He is doing this because he believes that he can beat the market. However, research shows that few investors can beat the market in the long-term.
… with your aspirational portfolio you will know what you are doing…
This is why if you don’t understand the investment, it is usually best to invest in a passive index fund. But with your aspirational portfolio you will know what you are doing. The investment will be based on your expertise. You will be building a business. As such, assuming you succeed, you will earn significant returns. And as Warren Buffet suggests, you will manage your risk using a margin of safety approach (where this is relevant).
Securing your kids future!
So how does this work when it comes to securing your kids’ future?
The first thing you need to do is organize your investments into the three portfolios:
- Emergency Fund
- Diversified Long-term Portfolio
- Aspirational Portfolio
You can break up the aspirational portfolio into smaller portfolios of varying risk. Because you have your retirement taken care of by the long-term portfolio you can afford more risk in the aspirational portfolios.
After you have settled the most important goals…
Now here is where goal setting comes in. You have already taken care of the two most important goals. Protecting yourself in the event of an emergency or when you retire. This is important. You are not much use to your children if you cannot look after yourself.
Now you need to prioritize your next goals. These might be:
- Securing your kids’ future
- Putting money aside for your favourite charity
- Wealth generation: becoming rich!
To meet any of these goals you need to have additional disposable income over and above what you need for your emergency and retirement funds. One of my clients next goals is wealth generation. He is funding this goal from his high salary. Another of my clients wants to secure his kids’ future. He is doing this by developing his own business.
How will you know when your kids future is secure?
The goal of securing your kids’ future needs to be spelled out. How will you know when your kids’ future is secure? What things do your kids need? What needs to be in place? For one of my clients this meant that his daughter needed a car. She also needed her college education paid for. For yet another, he wanted investments for his kids. Property, commodities, expensive watches, education paid for, etc.
With a good education your kids will probably have a secure future. Or at least as secure as you can make it. They will be able to find a good job. They will have the wisdom to make good choices about their future. And they will appreciate your help to achieve this.
But let’s say you want to add a bonus. In the United States for example, having a car is definitely a necessity for a college student. So, we can make that two goals for your daughter. And including your other two portfolios we now have four goals.
I have already explained how to calculate the required return for your retirement portfolio. And your emergency fund is not really intended to grow. However, it is ideal if your emergency fund value grows in line with inflation.
Where do your kids portfolios fit in?
If we were to look at the aspirational portfolio as yet another smaller pyramid then your kids’ portfolio will form the bottom base of this pyramid. So, you can take a lot of risk with the wealth generation portfolio. This will sit at the top of the pyramid. Your kids’ portfolio will sit above your retirement portfolio. And below your charity and wealth generation portfolios. Thus, you can tolerate relatively less risk with the kids’ portfolio.
So, let’s say that your daughter is currently two years old. You want to make sure that she has sufficient money to pay for college. This will be in 16 years’ time. How will you know how much to save for this?
The first place to start…
The first place to start is the cost of a college education today. Well the average cost of an Ivy League college was $60,000 per year in 2014. And the price of a college educate goes up by about 8% per year. So, in 16 years’ time, the cost of a college education will be around $280,000. And it will go up by 8% per year after this. So, the total cost for four years will be around $1.3M. You can actually figure this out using a financial calculator.
Now you also want your daughter to have a certain level of independence. Perhaps you want her to be able to easily return to visit you. And so, you want her to have a car. And since you only want the best for your daughter you decide on a Tesla. The particular model currently costs $100,000. How much will that cost in 16 years? Well average inflation on cars is 2.41%. When your daughter starts college, this same car will cost $161,000.
So, in 16 years’ time you will need a portfolio of $1.4m to ensure that your daughter’s future is secured. How do we get here? Well you have the following information:
- The required future value of this portfolio is $1.4m
- The time horizon is 16 years
- There are no emergencies that would need to be covered by this portfolio
- There are no unusual tax implications or unique circumstances that would apply to this portfolio
- You will have a higher risk tolerance for this portfolio than for your retirement portfolio
- So what return do you need to meet this goal?
Calculating the required return is easy!
Now that we know how much we need in 16 years, calculating the required return is easy. We can just use a financial calculator. We will make the following assumptions:
- You already have $200,000 set aside for your daughter
- You invest all of this money in an index fund earning an average 10% return
- Taxes on this portfolio are at 20%
In this case your required post tax return would be 8% (10% taxed at 20%). This means that you would have to make annual contributions of around $24,000. $2,000 per month.
What if this isn’t achievable?
If you felt that a $2,000 per month contribution was not achievable for you then you can make some changes. Maybe you set aside a larger amount. For example, if you set aside $300,000 then your contribution would need to be $1,000 per month.
Or perhaps you settle on a smaller goal. Maybe your daughter will find a way to buy her own car. Or go to a cheaper university. Or maybe you focus on building up the wealth generating portfolio. If things go well there maybe you can contribute more in the future. There is no end to the possibilities.
This is how you secure your kids future!
So, in summary, this is how you secure your kids’ future. You secure their future by first securing your own:
- Develop an emergency fund
- Build your retirement portfolio
- Prioritize your goals into your aspirational portfolio:
- Kids
- Wealth generation
- Charity
- Wealth generation can be used to feed your kids’ portfolio and/or charity
- As with any goal:
- Calculate how much you need
- Determine your time horizon
- Determine your initial contribution
- Figure out how much you can contribute
- Calculate the required return.
In my next article I will talk about banks and why they are last places you want to keep your money. They have lousy interest rates and they are nowhere near as safe as people think they are. And I will have plenty of ideas on how you can beat their rates.
If you want to know more about securing your kids’ future reach out to me. I’m always happy to answer questions. Until next time.
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