Children and wealth: too much, too young?

It is surprisingly “easy” to make a child wealthy. They have time on their side, which means every euro you invest for them can grow over a period of many years. A relatively small commitment from parents or grandparents, compounded over decades, can turn into a large sum that will give your children extraordinary flexibility and financial freedom later in life.

For example, €500 a month, invested with a rate of return of 5% per year, would grow to €174,600 after 18 years. If you are brave enough to take more risk – and if you are investing for more than a decade, you have plenty of time to ride out the highs and lows of stock market movements – you may be able to obtain even higher growth. At 8.9%, the long-term rate of return on the MSCI World index, this would build a lump sum of €265,190. Past performance is of course no guarantee of future results.

This alone would be a meaningful start to building children’s finances, giving them enough money for a deposit on a home, or higher education costs. If they could be persuaded to leave the money untouched until they were 30 – and even with no further contributions but simply letting the mechanics of compound interest do their work – it might grow to €482,260 at a 5% rate of return, or €768,000 at 8.9%.

With a combination of diligent saving, sound investment and time, it is possible to make your child relatively wealthy. However, the question as to whether you should hand your child this sort of wealth is more difficult. There may be downsides to passing on significant wealth to your children, particularly while they are still making decisions about their life and career.

A combination of diligent saving, sound investment and time can make your child relatively wealthy. But whether you should hand your child this sort of wealth is a more difficult question.

Rising living costs

The instinct to give children a strong start in life is understandable. Life is unquestionably more expensive for young people today. After many years of home price rises and relatively slow wage growth, it is more difficult to get onto the housing ladder. In Luxembourg, for example, apartment prices have risen by between 75 and 90% over the past decade, while average household incomes grew only by between 25 and 32%.

Meanwhile, inflation has pushed living expenses significantly higher. Educational costs have risen, leaving many young people to graduate with increased debt. The employment market is less secure and job turnover is higher. Many parents may conclude that the only way to get their children launched on an independent life path is through inheriting wealth.

There are other considerations. Older generations may believe that they have enjoyed a disproportionate share of economic rewards and are morally obliged to share their good fortune. American baby-boomers make up just 20% of the country’s population, but own 52% of its net wealth, equivalent to $76 trillion. They have also been the beneficiaries of significant government spending in the form of increased pensions and healthcare payments.

Psychological cost of wealth

However, one should also consider the potential psychological implications of inheriting wealth. For example, it may deny children the satisfaction of achieving success on their own merits and on their own terms. They may feel that their success has been bought, and is therefore ill-deserved.

It might also deprive them of incentives that drive other members of their peer group. They may lack the motivation to overcome early hurdles to achieve the prize of a successful career, because their path has been smoothed by inherited wealth. Why spend those extra few hours in the office if you know you have the money anyway to enjoy financial freedom?

There is also the so-called paradox of choice. You can use your wealth to give your child unlimited choice in the life that they pursue, but rather than making them happier, this breadth of choice could cause them stress, anxiety or decision fatigue.

There is also the so-called paradox of choice. You can use your wealth to give your child unlimited choice in the life that they pursue, but rather than making them happier, this breadth of choice could cause them stress, anxiety or decision fatigue. It may cause them more regret over paths they didn’t take, or at an extreme, create a feeling of paralysis.

Children may even become used to the trappings of wealth, a phenomenon known as hedonic adaptation. This theory argues that most people have a baseline level of happiness and ultimately return to that baseline after significantly positive or negative events. This implies that giving children significant wealth is unlikely to make them meaningfully happier, and may actually leave them more vulnerable to disappointment if they can’t maintain the lifestyle to which they have grown accustomed.

Separation and isolation

Substantial wealth may also be isolating. If your child’s friends are struggling as they have less assistance, privilege can create a divide. Their friends may be resentful, or believe they should be sharing more of their wealth. The child’s social circle may narrow to a handful of people in the same position as them, limiting their life experience. History is littered with cautionary tales about young people who received too much wealth at too early an age, limiting rather than expanding their life choices.

There is a balance to be struck. Parents have a range of tools at their disposal to help address the problem of children inheriting too much, too soon. It is possible to give children a head start, and a measure of financial freedom, without damaging them psychologically.

For example, money can be placed in trust until an age at which the family feels the child is ready to handle it. Trusts allow money to be held back until certain criteria are met – marriage, for example, completion of education, or arrival at a pre-determined age. This can ensure that capital is protected against youthful recklessness and high spirits, or the unwelcome influence of third parties, and that it is invested and managed in a sensible and productive way.

Trust can ensure that capital is protected against youthful recklessness and high spirits, or the unwelcome influence of third parties, and that it is invested and managed in a sensible and productive way.

Benefits of allocation to pension schemes

Another good option might be to use a pension scheme. Personal pensions increasingly have limits on when money can be received, which varies across Europe, but is usually between the age of 55 and 60. That might mean you having to wait a very long time for any thanks for your generosity, but it makes it less likely that the money will be frittered away.

It can also be a tax-advantageous option, with many countries offering tax credits for pension contributions. It also means that the child won’t have to save as much during their lifetime to support a comfortable retirement. The effect of compounding is particularly astonishing. That €174,600 sum at the age of 18 could grow to €1,284,780 if left untouched for 40 years.

It is possible to make your children wealthy. A relatively small outlay from generous parents, friends or family can go a long way if it is invested in the right way and long enough. However, parents need to set parameters around inherited wealth in order to avoid some of the well-documented problems arising from too much wealth, too young.