Monevator reader James has a question about Junior SIPP asset allocation as follows:
In the good times I opened SIPPs for my children and I followed my standard policy of buying Vanguard Lifestrategy 60/40.
However, buying an investment to hold for 50 years or more is obviously very different from buying one for my elderly self. What are the considerations and options?
The Internet is weak on this one. But I have strong views!
Invest 100% in a global equities tracker fund. Then leave it to grow knowing you’ve done the best you can.
My reasoning is straightforward.
A Junior SIPP banks on the power of compound interest to multiply the pounds you invest with love into a legacy your child can enjoy when you’re gone and can do no more.
Play with our compound interest calculator. You’ll see that this money multiplier is twin-engined. Compound interest needs both time and a suitably high rate of return to truly work its magic.
The most exciting stuff begins to happen after 40 years. That is when the trail of wealth arcs up like the trajectory of a rocket ship – rather than a biplane bumping along the turf.
Even then, you’ll want to target the highest rate of interest (or rather investment return) you can reasonably hope for – without resorting to magical thinking.
And as far as I’m concerned that amounts to the 5% annualised return (after inflation) delivered by world equities for over a century.
Investing returns sidebar – All returns quoted in this piece are real annualised total returns. That is, they’re the average annual return (accounting for gains and losses) realised in a given time period. These returns include the impact of reinvested dividends and interest, but strip out the vanity growth delivered by inflation that does nothing to grow your actual spending power.
Bonds have historically generated an annualised return of 1.5% after inflation. That rate of return will not compound quickly enough to make your kid comfy in their old age.
Here’s the graph of compounding bond returns. You’ll notice there’s no magic hockey stick effect – even after 60 years:
Time is on their side
It’s natural to be protective of your child’s money and to be more cautious with it than with your own.
But your child should have a lifetime of investing ahead. That makes their risk tolerance and time horizon very different from yours.
The kiddiwinks can’t touch their SIPP money until their late-fifties at best. The way the political weathervane is spinning, they may even be in their sixties by the time they’re permitted their allowance by our benevolent AI carers in the far future.
Tack on a 40-year long retirement and the contributions you put in now could still be making a difference in 90 to 100 years’ time.
The key point is that your child does not have a short-time horizon problem. So they don’t need to diversify like you do.
Most adults save for retirement over 30 to 40 years, tops. Even if you eat risk for breakfast, you should be easing back on equities for the last ten to 15 years.
Otherwise, cop a lost decade or two in the middle and the time-pressure is enough to make anyone panic. Hence the investment industry hit upon bond diversification to hold the crazy in check.
But this rationale does not apply to a child who doesn’t need the money for half a century or more.
If a big, bad bear market comes along – it won’t touch them in the long run. Junior’s pension money can be underwater for ten, 20, even 30 years and it doesn’t matter.
In fact, it may even help. The shares you bought will keep spinning-off dividends, which will be reinvested to rack up even more shares bought at bargain prices.
Meanwhile, lower returns in the present mean higher expected returns in the future – hopefully as your child hits their peak earning years.
Who’s gonna freak out?
Think about this, too: when your child’s equities are hit by a market convulsion, who’s gonna hit the panic button?
They’re playing with Peppa Pig when it happens, or their mobile – or later with somebody else still many decades away from even thinking about thinking about retiring.
And when they do start work, they’ll be auto-enrolled into a pension fund that handles diversification automatically.
What are the chances they’ll even pay attention to the annual statements until their thirties begin to wear thin?
All you have to do is remain a steadfast steward of their SIPP until they hit 18. From that point on, they take charge. But they’re going to have better things to do. Much better.
If a temporary -50% portfolio blast probably isn’t going to bother them, then there’s no need to let it bother you. Historically, the market has recovered.
There’s a useful side argument here, too. Even with compounding, your efforts are likely to be the icing on a cake paid for by your child’s own lifetime of labour. And as mentioned, the bulk of their funds will be diversified by their friendly workplace pension company pals.
That relieves you of the pressure to play it safe. You may as well use your money to swing for the fences. (While still taking the sensible precaution of diversifying across every major stock market on Earth with that global tracker fund. I’m not suggesting taking a mad punt on crypto here).
It may help to conceptualise your child’s own future saving efforts as providing the floor that will underpin their retirement prosperity. In this model, your ultra-early contributions can form part of an ‘upside portfolio’ that will go towards the fun stuff.
Seen like this, you can again afford to take more risk on their behalf.
Take comfort in capitalism
Market history shows that the longer the time period, the more likely it is that investment returns will converge upon their historical average:
Data from MSCI. April 2023.
The chart shows the best, worst, and the simply average annualised results for every MSCI World rolling return path since the index launched in 1970.
The average annualised return across all 53 years is 4.5%.
But you can see on the left-hand-side that the average result exists within highly volatile polar extremes in the short-run. Returns range anywhere from 62% to -46% for a single year.
However these extremities are planed-off over time. There isn’t a single, negative timeline that lasts longer than 14 years.
Simply put, the longer your child remains invested, the more likely it is that they’ll get the average return.
Of course, there are markets with worse rolling returns out there if you want to frighten yourself.
We could talk about Japan’s shocking losses.
Or the German equity path that remained in the red for 79 years. Two devastating defeats in World Wars and hyperinflation will do that.
Less obviously, there’s an unbelievable French stock market timeline where you didn’t make money for 135 years.
The whole world is rooting for your kid
The solution in those grim outlying cases wasn’t to invest in the bonds of the blighted countries. Bonds were devastated, too.
The answer was to invest in the world.
Throughout history, someone somewhere has always held the baton for progress and kept humanity moving forward.
Whether it be the Greeks, the Romans, Byzantines, Arabs, Chinese, Enlightenment Europeans, or the Americans.
(Full disclosure: the author may or may not hold positions in some of these civilisations. Past performance is no guarantee of future success. Just ask the nearest moai.)
We can only focus on what we can control. If there is a global bear market that lasts 50 years, then 30% bonds and 10% gold almost certainly isn’t going to rescue anyone’s pension.
And so I circle back to 100% global equities and backing three wonders of the modern world: Capitalism, compound interest, and a low-cost index fund.
Take it steady,
The Minimum Pension Age is currently 57.
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