Lots of grandparents open bank accounts for grandchildren, keen to put them on a long-term path to healthy finances. Many parents do the same. With Christmas just around the corner it’s a good time to consider this approach.

Interest rates at the banks are around five per cent per annum. That looks attractive. However it doesn’t allow for inflation. Over the last three years inflation has been far more than the interest depositors have earned.

Savers must focus on the real return, the interest rate minus the inflation rate. If interest is 5.0 per cent inflation is 4.9 per cent, so that’s a poor return. If the depositor has to pay tax on the interest they are definitely going backwards.

Unfortunately the Tax Office won’t believe the parent when they say the investment is for the child and they won’t ever use it for themselves. The ATO assumes it is their money because they control it. They must include the interest in their tax return.

If the grandparent or parent is working they are likely to pay tax of 34.5 per cent or more, so they are way behind. If they aren’t working the interest equals the inflation rate. They need to earn more.

The good news is, if the child is young, they have many years ahead. This allows time for interest to compound and grow much more, and they can tolerate some fluctuations and uncertainty.

Long term, shares and property outperform fixed deposits. So the investor can choose a share fund investing in major companies. Financial advisers have seen excellent results from such strategies over 15 or 20 years. There are also balanced funds and growth funds with overseas share exposure.

The investor could also buy specific shares such as BHP, Telstra or Commonwealth Bank. The variations will be greater but the imputation tax credits will help.  

If both parents or grandparents are high earners tax paid bonds may suit. They pay tax internally, nominally at 30 per cent. However the managers say the effective rate is lower due to careful management of transactions.

After ten years bond payouts are tax free. If the grandparent passes away the bond can transfer to the child.

Bonds offer similar investment choices to managed funds, including shares, property and international assets. Accounts can start from $5,000. Investors can also add regular savings if they wish – $100 per month for example.

Money can be drawn out of managed funds or investment bonds at any time if the child has a particular need, such as a health problem or education costs. Consider starting an investment to put a grandchild on a positive financial path this Christmas.