“The theory is that each time I have a child born, I would invest $22,000. The key is that the investment is not for my children but for my grandchildren. So for example, my child, let’s call him Tim.
“When Tim is born I invest $22,000. When Tim turns 65, the investment is worth, say, $1 million. Each of Tim’s children (who would be probably 30-40 years old) would be entitled to get a split of the payout. Note Tim does not participate in the investment.
“For Tim’s children to receive their share, all they have to do is make an equivalent investment for their children to keep it running. They could make it out of their share of their payment.
“This may sound complicated, but the only difficulty I can see is the initial investment to be made. However, once past that hurdle, the scheme is self-perpetuating and, if you look forward far enough, covers potentially hundreds or thousands of descendants.
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“I’m curious if this is a worthwhile idea or not. Considering the opportunity cost, what do you think? Note I have not yet thought through the funds management aspects or the ‘trustee’ responsibilities in 65 years.”
A: I love it – even though your email makes me feel as if I’m back at high school, and I’ve been conned into helping someone do their homework!
Other readers’ main objection to doing something similar themselves, I suspect, will be that many couples making babies don’t have $22,000 sitting around. But they could start with, say, $5000 or even $1000, and make a point of adding to it as soon as possible. Or in some cases, a grandparent might help.
I like that your son isn’t committing others in future to putting in money they may not have, given they can use some of their gift to invest for the next generation of recipients.
Some issues for your son and others to think about:
Your son suggests a return of 6%. That would have to be after fees and tax. It’s probably a reasonable assumption if the money is invested in a share fund or a non-KiwiSaver aggressive fund.You would need to stick with it – not switching when the balance falls in a market downturn. If that’s likely to be difficult for you, use a lower-risk fund and settle for a lower end balance.As your son acknowledges, inflation will eat into how much a future balance will buy. But it will still be great for the recipient – for perhaps a house deposit, or to repay a chunk of a mortgage.The amount a recipient puts in to keep the scheme running would need to be adjusted for inflation.If you have more than one child, obviously you would want to do the same for all of them. But what if one of your children has more kids than another?Cousins will be treated unequally. Maybe that’s okay, but it’s worth thinking about.What if one of your children has no offspring? Perhaps you could specify that they give the money to a charity of their choice.
As your son notes, this would have to be set up with legal expertise.
Basically, he is making the most of the power of a compounding investment over a really long time. I say: “Go for it!”
Small difference becomes big
Q: Not a question, but a spectacular example of how a return of 8% versus 6% makes a massive difference after 42 years, is given in an online table I found.
The 6% after 42 years provides $597,000. But the 8% provides $986,000, being nearly two-thirds more.
A: You’re right. Over long periods, a somewhat higher return makes a huge difference. That’s why it would be best if the family in the previous Q&A, or anyone who wants to copy the idea, uses a high-risk fund – probably one that holds just shares.
Stay with insurance
Q: One of the benefits I received at my previous job was fully subsidised Southern Cross health insurance (Wellbeing One plan). Unfortunately, my new role does not include this coverage.
I’ve since been in contact with Southern Cross, and continuing the policy independently would cost around $230 per month.
Given that I’ve made very few claims in the past, I’m considering the alternative of setting that money aside in a dedicated savings account to cover any potential future health expenses.
I’m in my late fifties, in good health and maintain a balanced lifestyle with daily exercise and a healthy diet. That said, I’m mindful that health needs can change unexpectedly.
My current policy is on hold until the end of August, so I need to make a decision soon.
I would really appreciate your thoughts or any guidance you may have on what might be the best course of action.
A: There’s no clear answer to your question – or the many variations on it that seem to come into my conversations often, now that my friends and I are no longer spring chickens!
Let’s just say that if I were you, I would keep the health insurance going. You may look back later and say you would have been better off if you had followed your self-insurance plan. But what people often ignore is peace of mind in the meantime.
It’s worth a lot to know that if you do suddenly develop a serious health issue, you won’t have to either wait for perhaps months to get help or find big sums of money for treatment. The last thing you need at that time is money worries as well.
And being in good health in your fifties – or sixties or seventies – certainly doesn’t come with a guarantee that it will continue. Clearly, leading a healthy lifestyle must help you to fight any health nasties, but it doesn’t prevent them.
On the other hand, you will be shocked at how quickly health insurance premiums rise as you get older. You can keep costs down to some extent by limiting cover to specialist care, rather than including GP visits, and by increasing your excess – the amount you have to pay before insurance kicks in.
How much? Dunno
Q: Another health insurance question. My husband and I are both 65 and face the common question of continuing our health insurance or to self-insure.
It is hard to make this decision without a ballpark figure for self-insurance. I totally appreciate everyone’s health is so variable and I understand the reluctance by brokers to provide a figure, but some guidance would be helpful and appreciated. Can you help?
A: Sorry, but no. Or, if you insist, several hundred thousand dollars.
Some medical procedures, including scans and surgery, cost thousands. What’s more, you can’t predict whether you will need several procedures at much the same time, as different parts of your body decide to misbehave.
When to switch
Q: You often refer to switching funds as locking in your losses. I never fully understood that.
It makes sense to me if one switches funds because they are scared during a market drop and switch to a lower-risk fund long term.
But in your view: does that apply to all fund switches? What are the risks when switching a fund? If I switch to a higher-risk fund while the market is down, do I still lock in any losses?
I know timing the market is futile, but I don’t understand what the downsides to switching at any given point are.
A: I’ve been waiting for the markets to wobble again before running this Q&A. Funnily enough, it hasn’t really happened for a while. Then again, it could happen between my deadline time and the time you read this. So let’s get on with it!
First, we’ll look at switching to a lower-risk fund during a downturn. Let’s say that your account balance falls from $20,000 to $15,000.
If you worry it will fall further, and therefore you reduce your risk, you’ve locked in the $5000 loss. You won’t get that money back again when the markets rise, because your new fund doesn’t hold many shares, if any. And recovery always happens – although sometimes it takes a while, and occasionally several years.
If, however, you had stayed the course, your balance would have returned to $20,000 or higher. You would have lost nothing.
In those circumstances I would say, “Sorry, but if you can’t cope with volatility you shouldn’t have been in a high-risk fund in the first place. But okay, if you really can’t sleep, just take the loss and move to lower risk. And, importantly, stay there”.
On other fund switches, it depends. If you move to higher risk during a downturn, that’s a pretty good move. You’ve bought at a relatively low price and will benefit when prices later recover.
That’s called contrarian investing – moving in the opposite direction to most people. The trouble is it involves market timing which, as you say, is a fool’s game. When the market falls, for example, we never know if it might fall a long way further, followed by a slow recovery.
So the rule is: reducing risk in a downturn is bad; increasing risk in a downturn may be good – but only if you’re lucky. Usually it works far better to just get your money into the correct risk level for you, and leave it there.
There are, however, two circumstances in which moving risk makes sense:
You’re getting nearer to the time you expect to spend the money. In those circumstances, it can work well to move your money in, say, three lots, a month or two apart. That way you avoid happening to make the move at a bad time.You realise you can’t tolerate downturns as much as you thought you could. But, as stated above, you must then stay in the lower-risk fund for the long term.
Not so possible
Q: In regard to your comments on the use of aggressive funds by the elderly or those entering retirement, it is of course possible to do well by transferring money from an aggressive fund to a cash fund or similar when the aggressive fund is showing a peak balance.
Over six months to a year, the aggressive fund will rise and fall similar to the Dow or Nasdaq index. Of course it’s all about timing, but for those who follow the world indices figures, such as the VOO or similar, it is not too difficult to do.
A: It’s not just difficult, it’s impossible if you want to get it right more than occasionally by luck.
As I’ve said often, it can work well for retired people to hold money they expect to spend in 10 or more years in an aggressive fund – usually a fund that holds shares only. But it’s not a good place for shorter-term money.
Your balance in such a fund can quite suddenly plunge – occasionally as much as halving. And, as noted above, recovery can sometimes take several years. Meanwhile, the grocery purchases can’t wait.
You’re suggesting we simply watch how the markets are moving and switch to a lower-risk fund at market peaks – in other words, right before a market downturn. The big question – one that every active fund manager in the world would love to be able to answer – is when a market has peaked.
Getting that right repeatedly can’t be done. Every now and then a fund manager does well, reducing risk right before a crash. Convinced he – or rarely she – has learnt the secret, investors rush into their funds. And once in a golden moon, the fund manager gets it right a second time or third time, and even more investors jump on the wagon. And then, uh oh!
If you want to try to do this with a small amount – let’s call it play money – go for it. And good luck! But I would never suggest it for others.
* Mary Holm, ONZM, is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. Her opinions do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.