Generational Wealth....Solved!

Recently while skimming Instagram, I came across a short video. The host stated that it only takes $6,000 in a Roth IRA for your child by age 15 to have $1,000,000 by age 60. The discussion was about how a parent can essentially ensure that their child retires comfortably with minimal effort. The person who stated this assumed a 12% annual return on the investment. Now, while I know the rationale to be true (based on the time value of money, the average return of the various stock market indices & compound interest), I could not help but think: “Wow, do people REALLY know that they can change their child’s life for $6,000?” In fact, it costs even less to build a $1 million dollar nest egg for your child if they are younger than 15 (and consequently more if they are older than 15).

Let us unpack this for a moment: one of the most important goals in our lives is to build enough wealth to retire comfortably. Additionally, most of us want to leave wealth to our children so that they start their journey on the wealth-building path much further along than we did. As the markets have thrived over the last several decades, the personal wealth of those invested has grown substantially.

To quantify this growth, let’s look at the 10-year history of the NASDAQ Composite index. The NASDAQ, one of the 3 major benchmarks used to measure stock market performance, has returned about an 18% return on average since 2011. At an annual 18% return on investment, your money doubles about every 4 years. Over a ten-year period, your initial investment increases by approximately 423%. Said another way, if you had $10,000 invested in year 1, you would have approximately $52,238 at the end of year 10. By year 20, you would have about $273,930 and in year 30, your account balance would be just over $1.4 million dollars!

The exponential growth of invested accounts becomes quite evident quickly in the forecast mentioned above: the 18% return on your initial investment of $10,000 in year one is $1,800. However, the 18% return on your projected account balance in year 20 of $273,930 is $49,307! To put that in perspective, the average salary in the U.S. in Q1 of 2020 was $49,794. This means that at some point throughout the life of this account you would cross a threshold where the annual interest earned in this account exceeds that average salary of a person working a full year.

Why is this important? Because there are funds that you can easily buy that mirror the performance of the various stock market indexes. For each of the 3 major indexes (Dow Jones, S&P 500, NASDAQ), there are several ETF’s, or exchange traded funds available to purchase that are built to perform almost exactly as the index performs. If the NASDAQ increases by 3% on any given day, the exchange traded fund QQQ, will move by approximately the same percentage. Did the Dow Jones industrial Average dip by 2% today? If yes, so did the ETF that tracks it, called the SPDR Dow Jones Industrial Average ETF (stock symbol is DIA).

By simply taking your initial investment, creating a Roth IRA for your child and buying shares of the ETF that tracks the various indexes, you essentially lock in their performance over the life of the IRA. Do this when your child is 10 years old, and you create an investment tool that grows for 50+ years until retirement age. Do this at age 15 and the account grows for 45+ years. Assuming your child meets all of the rules of the Roth IRA, they will be allowed to withdraw this money TAX FREE at retirement age. I should note that your child does need earned income to be able to contribute to a Roth IRA.

Below is a quick chart that highlights the performance of the big 3 indices over time:

By making an initial investment while your child is 10 or 15 years old and dropping it in a ROTH IRA on their behalf, you can literally turn $6,000 into $1,000,000+ with absolutely no effort or energy from you or your child. The only requirement is discipline (to not touch the funds) and patience. Throughout their entire life, they will:

1). Always have a financial cushion that is not dependent on their income, and;

2). Worry less about saving for retirement, allowing them to make choices that focus on what they WANT to do versus income.

Wait!? $6,000 can provide my child with a life of choice? While I am over-simplifying this a bit, the answer is yes. It takes most of us 20 to 30 years of working and contributing to a 401K or other retirement account because we don’t start until our early or mid-20’s. However, start this process sooner and the added time that the money can grow has a profound impact. Without the burden of worrying about retirement, a person can be free to choose a path in life that focuses more on what makes one happy versus taking the job that pays the most.

Additionally, all of the growth from the contribution referenced in this blog happens…. WITH NO ADDITIONAL CONTRIBUTIONS! A one-time investment single handedly creates wealth for your child. Add this account to any retirement account that your child funds throughout their life on their own, and they reach retirement with several million dollars’ worth of wealth that can be handed down to future generations. Let us then add any wealth that YOU acquire throughout your life that can be left to your child (homes, cash, life insurance, remaining balance of your 401K), and you have changed the trajectory of your family for generations to come.

You have created wealth where there was none before, and you did not start a business, create a product, score a touchdown in the NFL, or do any of the thing’s society has convinced us that are required to achieve wealth. You simply made a good, simple, smart investment early in your child’s life because you understood that the math of compounding interest is a power tool that can be leveraged to do great things. Albert Einstein said it best: “Compound interest is the eighth wonder of the world. He who understands it, earns it….he who doesn’t…pays it”.

Final Thought: Roth IRA contributions don't have to be a one-time contribution, you can contribute to your child's Roth IRA over time to get to $6,000 (or more). You only need to make sure that your child has income in a given year to be able to contribute.