How the bank of mum and dad can help their children buy a home

The bank of mum and dad can use this simple strategy to help get their children on the property ladder. But starting early is key.

Parents are their children’s best avenue for buying real estate early. Picture: iStock

The bank of mum and dad is increasingly vital for young adults buying real estate, and for parents wanting to lend a hand it’s best to start early – really early.

Today’s surging home pricesmake it seemingly impossible for most young adults to buy property without help from parents or grandparents.

It’s sadly creating a two-tiered society where intergenerational wealth is a prerequisite for home ownership and the financial freedom and tax benefits that this brings: families with houses own more houses, while renting families struggle indefinitely.

But it doesn’t have to be.

The power of compound interest, good long-term planning, and disciplined saving and investing means parents can give their children a foot in the door of future property ownership. But they will have to start early – preferably before mum and the new baby leave the maternity ward.

Putting a small amount of money away every week from day one of a child’s life can grow exponentially over the almost two decades before they reach 18, becoming a sizeable deposit for a rental property or their own home. In many cases, sharemarkets are a family’s top ticket to this long-term investment growth.

Compound interest works wonders over time. Punch a few numbers into ASIC’s compound interest calculator at moneysmart.gov.au and you will see that $40 a week can grow to $117,000 over 18 years, assuming dividends are reinvested and the total annual investment return is 11 per cent – in line with long-term performance of shares over many decades.

If parents bump it up to $50 a week, the end result is $146,000, and injecting $60 a week grows to $175,000. Of course, property values will rise too in that time, but after two decades of stellar price rises and amid today’s huge affordability barriers, they may be due for some subdued growth ahead.

A broad diversified share portfolio of local and overseas shares is easier than ever to build thanks to the boom in low-cost exchange-traded funds, where just one share can give you access to all of Australia’s top 200 stocks, or the 500 biggest stocks in the US, or a selection of the world’s largest companies.

As a guide, the Vanguard MSCI Index International Shares ETF holds 1200-plus stocks including Nvidia, Apple and Microsoft, has average annual returns of almost 14 per cent since it started in 2014, and has a management fee of just 0.18 per cent.

For Australian shares, the nation’s most popular ETF – Vanguard’s Australian Shares Index fund – invests in almost 300 companies, has generated average returns near 10 per cent since launching in 2009, and its management fee is 0.07 per cent.

There are plenty of other ETFs to choose from, so parents don’t have to be stockpickers. They can simply follow the advice of billionaire investment great Warren Buffett, who said “stick with low-cost index funds”.

The bank of mum and dad plays a big role in their adult children’s lives. Picture: iStock

Shares can be volatile, so parents using them to save for a home deposit for their children should consider selling down during the few years ahead of the planned property purchase, to guard against a sudden sharemarket plunge similar to the 50 per cent-plus falls suffered over 2008 and 2009.

Parents also need the discipline to avoid dipping into the money earmarked for their children simply because it’s there.

When working as a financial planner two decades ago, I had to bite my lip when clients said they continually used their child’s education savings money to meet their own everyday expenses.

Yes, making ends meet is hard and living costs are high, but many of us waste a lot of money on a lot of crap. And there are plenty of other ways to save money rather than raiding a child’s future.

If parents or grandparents worry that they have missed the boat because the children are already at school age, tweens or teens, remember that doing something is better than doing nothing. The children, once they know the plan, may be motivated to tip some of their earnings from part-time work into their property savings stash.

Property prices have climbed so much faster than wages in the past three decades, so today’s parents and grandparents should consider stepping up more than their own parents did.