Thursday, 20 December 2007

The Millionaire Baby Next Door

Consider baby "John Doe". John's father starts doing some overtime (or a second job) as soon as he finds out John is on the way. When John is born he manages to scrape together $12,000 to invest in a low-cost investment fund. If the fund's total return averages 11% pa, the child's investment returns are taxed at 25%, and inflation averages 2% pa, the real, after-tax, return of the investment would be 7% -- and the investment account will hold just over $1 million (in today's dollars) when baby John turns 65.

Of course very few expectant parents would have a "spare" $12,000 lying around when a baby arrives, few dads would go out and earn an extra $12,000 during the pregnancy, and, if they had the choice, most people would probably put the $12,000 towards baby expenses rather than invest it for 65 years -- but it does show what can be achieved with a fairly modest amount invested for a long period.

If a lump sum of $12,000 is beyond reach (after all, that would require putting aside $33 a day for a year), the same result can be achieved by investing $1,000 each year for ten years (ie. finding an extra $3 a day to invest for the child), provided the investment return is somewhat higher (13% instead of 11%) or if the money was invested in a tax-sheltered account (such as a child superannuation account).

If one did both - investing an initial lump sum of $12,000 and then adding a further $1,000 each year until John Doe turned ten, John's investment would reach $1 million (in today's money) by age 58.

Copyright Enough Wealth 2007


minimum wage said...

Here's a more leisurely approach which produces a somewhat similar result.

Starting at birth, Dad invests $1 per day ($30/month). When John is able to earn his own money, John takes over the monthly contributions. (There will be a transition period during which the child will be able to earn something but not $30; Dad will continue to contribute enough to bring the total investment to $30.)

If continued at 8% John Doe will reach $1 million around age 68.

ZachStocks said...

good point minimum...

The only problem is that when he is age 68, one million will be enough to pay for a nice two week vacation abroad because of inflation. If instead you used $2.00 per day and compounded at 10% you would come up with 2,800,000 - but inflation will still be an issue to deal with.

Debt Dieter said...

You could also use the baby bonus as a starter fund too no doubt?

Assuming it's an Aussie baby of course! :-)