Dollars for toddlers
Saving for a child's education should begin early, writes Nicky Burridge
Alicia Eaton's twins are only three-and-a-half-months old, but she has already started saving for their future.
Eaton, who runs her own business with her husband in Hong Kong, started setting aside money around the time she decided to have children. Initially, the savings were a contingency in case anything went wrong.
“We are not saving for anything in particular. Having twins, we thought it would be a good idea to have some spare money around we could quickly access in case we ever had the need,” Eaton says.
She and her husband both pay a set proportion of their salary into an equity investment each month. “We decided to invest in the Hong Kong stock market as it was relatively easy to set up with HSBC, and also helped us gain new skills in understanding the markets in Hong Kong and China.”
Whether it is saving for a college fund, a wedding or just to help get their children started in life, most parents, and increasingly many grandparents, want to set aside some money for their offspring.
But the process can seem daun8ting if you are not an experienced investor, while the birth of a child is often a chaotic and expensive time of life.
Jessica Cutrera, a financial adviser, says parents should start saving early. “Starting young, whether it is ? a retirement fund or college savings, makes a huge difference,” she says.
The first thing parents need to consider is what they are saving for. If they are saving for university and their child has just been born, it will be at least 18 years until they need the money.
By contrast, if they are saving for school fees, they will need the money much sooner. They will have less flexibility to invest in higher volatility assets with greater long-term payouts. In other words, their investment will be more conser8vative and lower return.
Parents also need to think about what currency they will save in if the money is likely to be used abroad.
Those who are not Hong Kong locals should investigate whether there are any tax benefits to choosing one type of investment plan over another, or whether transferring money into their child’s name will inadvertently create a tax liability for them.
Cutrera says: “In Hong Kong you may not pay tax on dividends and capital gains, but for US citizens, taxed on worldwide income, who are potentially going to set aside money for college, there are certain types of accounts you can use that grow tax free.”
One type of plan, known as 529 plans, can be opened in Hong Kong through US-licensed represen8tatives. But the money can only be used to fund higher education, otherwise the gains are taxed.
How much should you save?
Deciding how much to save is difficult, particularly at a time when parents are facing all the financial demands of a baby.
Financial adviser Robert Flux recommends parents work with a financial planner to forecast how much it will cost to see a child through university.
“They will factor in inflation and the rate at which the fund is likely to grow, depending on your invest8ment parameters, to help decide how much you need to set aside as a lump sum or on a regular basis.”
Sheila Dickinson, also a financial adviser, recommends doing a budgeting exercise of household expenses to see where additional savings can be made.
The next step involves assessing future educational plans in detail.
“Then we would look at where they would like their kids to go to school, which country, what type of school, and what course,” Dickinson says. “We would also look at other costs, such as the cost of living.”
She adds it is important savings goals fit into the household budget. “It has to be realistic,” she says.
Picking the right product
Many banks and insurance com8panies in Hong Kong offer savings plans specifically designed for children’s education.
But Cutrera is not a big fan of many of these products, which often contain a life insurance element for the child that can be expensive.
She adds the plans often have high charges, which are front-loaded, and inflexible, forcing parents to commit to saving a set amount each month for a set period of time.
Instead she favours buying direc8tly into tracker funds set up through a flexible investment account, as they are generally low-cost and do not have front-loaded charges.
“On average somewhere between 70 per cent to 80 per cent of active fund managers do not beat their market index, meaning statis8tically you are actually better off picking an index tracker, and having substantially lower fees,” she says.
Some funds enable parents to get a broad exposure to a variety of markets, by tracking a range of market indexes.
But Cutrera warns that parents should still pay close attention to charges. Many index trackers have annual charges of 0.2 per cent or less, but some charge as much as 1 per cent a year.
This compares with annual management charges of around 1.5 per cent on actively managed funds, while some active funds and structured products have front-loaded charges of 5 per cent to 6 per cent.
Funds bought inside a life insurance wrapper, such as pension schemes sold by insurance firms, are likely to have further fees and charges of 3 per cent to 4 per cent a year or more.
Cutrera likes Charles Schwab, Interactive Brokers, and other low-cost platforms that offer clients access to a wide variety of index-tracking products.
She adds that BlackRock’s iShares has one of the largest groups of exchange-traded funds.
Other financial advisers urge caution when it comes to structured children’s savings products offered in Hong Kong. “We tend to think parents should have an open-ended savings contract. It gives them more flexibility in when they take the proceeds and what they can do with them. Their situation may change and they may need to access the money earlier,” says financial adviser Dickinson.
Meanwhile, Cutrera urges parents to do research before they select a product.
“A bank is going to be incen8tivised to sell you bank products, so you want to be able to critically evaluate your options, even if you don’t understand much about the underlying investment,” she says.
She adds that BlackRock and Morningstar have good websites with a lot of information on funds.
On what sectors should you focus?
As a general rule, a portfolio heavily weighted toward equities is approp8riate if the funds are unlikely to be drawn on for a long period.
“Historically, equities on a long-term basis have offered some of the best opportunities for growth,” Cutrera says.
“But if as an investor you are particularly risk averse and you ? would sell your investment if the market value fell, then equities may not be appropriate for you.”
Risk-averse investors are better off with balanced funds that invest in a combination of stocks and bonds, and are designed to be less volatile, Cutrera said.
Other advisers agree the investment strategy should weigh up inflation expectations.
“In general, parents should consider growth-oriented invest8ment funds with a higher percen8tage in the equity asset class,” says Bruno Lee, regional head of retail sales for Fidelity. “Given the longer term nature, parents may consider markets with higher long-term growth potential such as China or broader emerging markets.”
Another option for parents are so-called lifestyle funds, which invest in higher risk, but potentially higher return assets early on during the investment period, but shift into lower risk and more stable assets during the final years before the money is needed.
Devanshi Bhatnagar, a financial journalist and mother of two boys aged five and one, is investing in a range of assets for her sons’ education.
Bhatnagar holds some money in a fixed deposit account, with the children named as the beneficiary.
“We are saving with an Indian bank and can get 7 per cent on the money, and we know the capital is assured,” she says.
She is also investing in jewellery and gold, and she would like to buy a property for her sons in either her native India or Hong Kong.
She started saving as soon as both children were born. “We want to help them do better in life,” she says.
Paul, a father of two, is also considering putting money into property for his children. “I think property is a good bet if you get the location right. It offers a good hedge against inflation and if you are renting it out, you can cover your costs,” he says.
In whose name should you save?
Most investment fund providers offer a service enabling parents to set up an investment account in their own names, with their child named as a beneficiary. The money is then transferred to the child when they reach 18.
If the fund is held jointly in both parents’ names, they can opt to require both signatures in order for any changes or withdrawals.
“One question for parents when they are making a financial gift to their children is who really owns that money?” Cutrera says. “I would suggest that the parent retains ownership of, or control over the asset, with the child as the beneficiary. That way, when the child turns 18, they can’t decide they want a Ferrari instead of a degree.”?
She says parents may not want their child to have immediate access to the money as soon as they turn 18 years old.
“If you are potentially going to apply for financial aid at institutions, having a lot of financial assets in a child’s name can work against them as well,” she says.
Financial adviser Flux recom8mends using a trust structure, as this enables the benefactor to state what they want to happen to the money and under what conditions.
For example, parents can specify they want the money to be used for the child’s “education or general advancement in life”, offering some flexibility if the child does not go to university, but still preventing the money from being blown on something frivolous.
Parents can also include a clause enabling them to access the money themselves if their own financial circumstances change significantly.
A trust can be set up through a solicitor or a trust company, while some financial products may include trusts and corporate trustee services.