Who wants to be a millionaire?

WHO wants to be a millionaire? We all do, but it is not as difficult as you think. Given patience and time it can be done thanks to the magic of compound interest.

If you invest about 35,000 today, it should be worth 1 million in 50 years, with income reinvested, and given a 7 per cent annual growth rate.

American statesman Benjamin Franklin is credited with being one of the first to realise the potential of compound interest. He was so taken with the idea that he changed his will to leave $1,000 to Boston and Philadelphia, invested at 5 per cent for 100 years.

Thereafter, some money was withdrawn and the balance tucked away in another compound interest account for another 100 years. By the time the fund matured in 1990 it was worth some $7m.

Guy Tulloch, head of HSBC Private Bank in Scotland, said: "Compound interest is the interest earned on interest when the return is reinvested alongside the original sum. The results can be spectacular if you are prepared to save for the long term."

For example, if you invest 1,000 for 40 years at 10 per cent, you could receive 100 a year and your capital back at the end of the period. In total you have earned 5,000 over 40 years. If, however, you reinvest your income, you end up with more than 45,000 at the end. Inflation will eat into the value of your investment, but you still end up richer. And the bigger the sum you begin with and the longer the time horizon, the larger the rewards.

Phone a friend

To boost the stakes, advisers recommend considering adopting a family-friendly investment strategy so that wealth can not only be built up but cascade tax-free down through the generations.

No-one need give up ownership or control of anything. But bringing investments together under one manager, prepared to link accounts, should mean a more cohesive investment strategy, and at cheaper cost.

Privacy does not have to be compromised, as accounts are segregated, but a wider range of investment opportunities can be opened up at lower cost, while tax planning across the generations can be exploited to the full. Tulloch adds: "Every extra 1 per cent return, compounded over many years, can make a huge difference to the wealth which can be created."

Up the numbers and the results are startling. A 320,000 lump sum invested today could be worth 9.4m after 50 years or 18.5m over 60 years, given a 7 per cent net annual return. Seven Investment Management director Justin Urquhart Stewart says: "We are living in an age of austerity when every penny matters. Yet families are throwing money away by not thinking strategically about their investments."

Many families already run an informal "family bank" where members chip in to help with short-term loans, mortgages or deposits for a first home. Co-ordinating investment strategy is the logical next step. Indeed, in some cultures, investing together to create and protect family wealth is not only commonplace but seen as a positive duty.

Max your lifelines

When it comes to investing, your lifeline is your adviser, and finding a good one is essential, particularly if you want a long-term family strategy to survive the test of time.

Tulloch says: "For these arrangements to work, you need a trusted adviser who understands the family dynamics and can stand back and see the bigger picture."

Usually, a fee-based financial planner will take the role of "family doctor". He or she can look across the wider group to ensure maximum efficiency by co-ordinating, for example, tax matters, while each individual's affairs remain confidential from other relatives.

Financial planner Louise Oliver of Taylor Oliver said: "Financial advice is too often focused on an individual. The first thing I ask clients to do is draw a family tree. The greatest impact on most individual's finances are the affairs of other people, yet you can't just pry into them. This is where the financial planner comes in."

The planner will draw up an overall strategy and then turn, where necessary, to specialists for additional tax, law and investment advice. In other cases the family solicitor can co-ordinate a combined strategy.

Want to play?

If opting for a family strategy, the framework is crucial and will depend on the ultimate goal and the family requirements. At one end of the spectrum, you can have completely independent linked accounts. At the other, you could opt for entire financial integration. Either way, you need to agree a structure and controlling hierarchy.

The super rich, those with more than 25m, often manage their money via a "family office" structure where all their financial arrangements, from investments to car insurance, are organised for them by a company set up for this purpose.

At the head of this arrangement, a powerful matriarch or patriarchal figure may preside. They are likely to have been the ones who made the fortune in the first place and drive decisions.

Middle-class families will need to establish their own hierarchy. Everyone must be clear about the precise nature of the common goal, how it will be achieved and over what time horizon.

Beyond that, a family will need to select certain individuals who will be given greater powers of control to negotiate with advisers, set a mandate and when necessary intervene to change that mandate.

It is also vital to have an exit strategy. Geoff Tresman, chairman of Punter Southall Financial Management, warns: "At the outset, everyone will enter arrangements with the best of intentions but, as sure as eggs is eggs, at some point in the future, interests will digress and someone will want to get out. This does not have to be a problem if you have a well thought-out exit strategy, which many investment managers will build into their portfolios."

Where family members are interested in stock picking, they could set up a family investment club. At the wealthier end of the spectrum, family financial partnerships or investment companies might be considered. These can all be more complex to unravel.

Fifty-fifty

Investment is always a bit of a gamble, and inflation takes its toll. But the longer the time horizon, the more certain the outcome. With inflation at current levels, experts believe a 7 per cent annual growth rate, with income reinvested, is a reasonable expectation. Compound this over a long period and the impact is significant.

However, buying power will be eroded by inflation. If prices rise by an average 2 per cent annually, the investment will still be worth 3.6m after 50 years or 5.9m after 60 years in today's buying power.

Higher inflation is more of a drag. If prices were to rise more rapidly, by 4 per cent each year on average, then in 50 years the nest egg would only be worth an equivalent 1.4m after 50 years or 1.9m after 60 years. Still, it is a small fortune for future generations to look forward to.

Correct answer is...

With a bigger fund, participants can invest in a wider range of options, such as private equity, hedge funds and some emerging markets which they could not buy into on their own.

Killik & Co believes it is currently possible to achieve a return in excess of 7 per cent via a portfolio of equities, commodities, private equity, property and corporate bonds, adjusting the mix according to risk tolerance.

Head of research Mick Gilligan recommends picking equities with a geographical spread, not just sticking to the UK. He would mix stable, cash-generating stocks such as pharmaceuticals, tobacco, food and utilities with those hopefully producing higher earnings growth such as industrial companies, mining and emerging markets.

A typical portfolio designed to produce an annual return of 7.4 per cent for HSBC private banking clients would be 3 per cent cash, 35 per cent fixed income (including government, corporate and high-yielding bonds), 35 per cent equities, 5 per cent property, 4 per cent private equity, 14 per cent hedge funds and 4 per cent commodities.

Final answer...

Operating a family tax strategy can save future generations a fortune in tax which might otherwise be lost to the Revenue. Children's income and capital gains tax allowances can be used to offset adult liabilities. Every family member's Isa allowance can be exploited to the full.

Optimum inheritance tax planning can insure all wealth passes intact down the family line. This can involve giving away assets in the expectation that the donor will survive for seven years and no tax will be liable. On top of this, a programme of regular small gifts can also remove wealth from estates.

Tresman says: "One adviser can look at everyone's personal and capital gains tax allowances and make sure these are being exploited to the full for the benefit of the group. He could also put an inheritance tax strategy in place to make sure all allowances, such as tax-free annual gifts and gifts on weddings, are exploited and properly documented so money can be passed on tax-free."

Danny Cox, of Hargreaves Lansdown, says: "All too often bad decisions are taken when it comes to tax planning. Isas, for example, are wonderful for saving lifetime taxes but bad for death taxes, as the money goes into the estate."

It often makes sense to skip a generation and pass investments on to grandchildren. This can be done by a simple bare trust. The grandparent opens an account designated in the child's name. This is then taxed as if it were the property of the child. Once the child hits 18, he or she becomes the legal owners.

Where individuals wish to maintain a greater level of control they can set up a discretionary trust and retain power as a trustee. These trusts are subject to a 50 per cent tax charge on income, so are only suitable for investments which produce little or no income.

Another tax-efficient vehicle for passing on wealth can be a family Sipp (self-invested personal pension). Family members use the tax wrapper to save capital and income taxes while the money remains within the Sipp.

It can also open up wider investment opportunities. For example, they could jointly buy a commercial property, which may be attractive where a family business is involved.

Alternatively, cash can be passed down the generations by investing in a pension for younger family members. You can put 3,600 in a Sipp on behalf of someone who is not working, or up to their annual earnings for someone who is. The investments grow tax-free.

As plans stand, the Sipp holders could withdraw cash, subject to a tax charge later, provided they had enough pension elsewhere to guarantee a basic income in retirement. What the rules may be in 50 years remains to be seen. Indeed, in some cultures, investing together to create and protect family wealth is not only commonplace but seen as a positive duty.