Big investments for little people

Come 2012, universities can charge up to £9,000 a year for tuition, and most have indicated they intend to. Factor in modest inflation and living costs and a university education for a child born this year could cost around £100,000, according to figures from Hargreaves Lansdown.

It doesn't end when they graduate, either. Hargreaves also estimates that a child born this year will need an £80,000 deposit (15 per cent) to buy a property at age 25. The average first-time buyer price in 2011 is £124,000 - factor in long-term house price inflation to 2036 and the average first-time buyer property will cost around £533,000.

"Parents of 17-year-olds today may not be able to do much at this late stage to make a difference, but those with younger children have the opportunity to reduce the burden if they can manage to put away even quite a little money on a regular basis," says Jason Hollands of F&C Investments.

If you want to provide a nest egg to give your child a good start in life - whether it is a decent education or a foot on the property ladder - choosing the appropriate investment wrapper and populating it with the right investments is key. There are several options to choose from, ranging from deposit accounts to children's investment savings schemes, a children's investment fund and, come 1 November 2011, the Junior individual savings account (Isa). So which do you choose?

Savings with instant access

Financial advisers agree that the best savings/investment product to use will depend on two main factors: when the money will be required; and how much risk the investor wants to take.

Previously, the child trust fund (CTF) gave families an opportunity to save up to £1,200 a year in a tax-favoured environment; however, few fund management offered these products and the charges were often higher than for equivalent products outside the CTF wrapper. The CTF is now being replaced with the new Junior Isa, and the annual investment limit on both will be £3,600. For more on Junior Isas, see Nuts and bolts of Junior Isas.

Both these products lock away money until the child reaches the age of 18, at which point the adult will have no say in how it is used. "If the money will be required before age 18, perhaps for school fees, the new junior Isa and CTFs are not appropriate," says Danny Cox, head of advice at Hargreaves Lansdown.

NS&I Children's Bonus Bonds can provide a reprieve, with the added bonus that your money will be 100 per cent secure because NS&I is backed by the government. These are also tax-free, but you have to save for the full five-year term to receive the bonus. Savings can then be rolled over into another five-year bond and finally paid out on the child's 21st birthday.

An alternative is a deposit or savings account. Children cannot normally set up a savings account in their own name until age seven and, even then, most banks and building societies require a parent to co-sign. These also do not have the tax advantages of the aforementioned vehicles.

Nationwide Building Society recently strengthened its children's savings portfolio with the launch of three new branch-based accounts. There is one new account to reward existing savers, one aimed at new investors and one for those who want the long-term value of a fixed-rate bond.

The interest rates on the Nationwide accounts range from 2.1 per cent to 3.4 per cent, while the current rate on NS&I Children's Bonus Bonds is 2.5 per cent. Even allowing for the fact that children can generally receive interest paid gross, this is a small return given that inflation currently stands at 5.2 per cent.

In search of better returns

While past performance cannot be relied on as a guide to the future, over longer investment terms history demonstrates that returns on shares have generally outperformed those on cash, bonds and property. The Barclays Capital Equity Gilt Study, the definitive guide to long-term performance, says that over every 18-year period since 1899 there has been a 99 per cent chance of equity outperformance. The past ten years have been highly anomalous.

The table below shows the difference in returns between a £100-a-month investment in a cash savings account paying interest of 3 per cent a year, and in F&C's flagship Foreign & Colonial Investment Trust over the 18 years to 31 August 2011.

Notes: Figures from Lipper, with income reinvested. Return over 18 years from 31/08/93 to 31/08/11

Mr Hollands says: "It is understandable that parents are uncomfortable with the idea that their children's savings might go down in value. But the current combination of record low interest rates and above-target inflation means that cash savings will lose real purchasing power over time. Few people would put their pension savings wholly in cash for long periods of time, and with an investment horizon of up to 18 years, perhaps children's savings should increasingly be viewed in the same way."

While shares and funds might seem the best investments given an 18-year horizon, these cannot normally be bought directly by a child and are usually held in a designated account. The asset remains the parent's, which means there are no tax benefits.

You could choose a fund vehicle specifically aimed at investing for children. For example, the Invesco Perpetual Children's Fund, which requires low minimum investments and aims to achieve longer-term capital growth by investing in a portfolio of UK companies. But the fund comes with hefty charges - an initial sales charge of 5 per cent and a total expense ratio (TER) of 1.75 per cent

A more cost-effective way of accessing the stock market can be found in children's investment schemes. Similar to investment trust savings schemes, these are managed by the management companies of investment trusts and 'wrap' around the shares of investment trust companies. These schemes are lauded for their flexibility, simple administration and low costs.

Examples include F&C's Children's Investment Plan, which offers access to F&C's range of investment trusts, including global options such as Foreign & Colonial Investment Trust and F&C Global Smaller Companies, income specialists such as Investors Capital Trust and British Assets Trust, and alternative investments such as commercial property, private equity and even hedge funds - you have 12 investment trusts to choose from.

Scottish Investment Trust's STOCKPLAN: A Flying Start is a similar scheme with no initial plan charge or purchase charge (other than stamp duty and, as with all equities, a different buying and selling price known as the bid-offer spread) and no annual management charge. A Flying Start requires a minimum lump sum investment of £250, with a minimum monthly investment of £25.

Other providers of these schemes include Aberdeen Asset Managers, Alliance Trust Savings, Baillie Gifford, Dunedin, JPMorgan Asset Management and Martin Currie.

A children's investment scheme is an attractive option if you would like more flexibility than is allowed with a child trust fund, or if you want to invest more than the £3,600 annual limit a year. Unlike the child trust fund or junior Isa, there are no limits on the amount you can invest, and these plans accept regular contributions and can be written in trust.

The bare facts

Bare trusts are the simplest type of trusts and are created when a gift is made into a designated investment account with the intention of creating a trust. The child is the beneficiary and there are normally two adults - often the parents - acting as trustees. The child becomes automatically entitled to the investments at 18. However, the trustees can opt to distribute money earlier if required – for example, to meet school fees.

Comparing the different options

Source: Bestinvest

Tax advantageous investments

If you use a trust or children's investment scheme, keep an eye on how much income it's generating. If it's producing more than £100 a year gross, it'll be taxed at the parents' marginal income-tax rate, as if the income were theirs.

The new junior Isa gives parents the opportunity to save in a tax-favoured environment. While a number of providers are only planning to launch a junior Isa in 2012 (for example JPMorgan Asset Management and F&C Investments), there are players that will have a product ready come 1 November this year.

A Manchester-based independent financial adviser has teamed up with several fund providers to create a company that will offer junior Isas with a wide range of investment options. The Children's Isa, set up by David Dawson and Mark Albinson, is offering low-cost, actively managed, ethical and Shariah funds, and can be opened with a minimum investment of £10.

The low-cost option for The Children's Isa is being provided by TCF Investment's Total Clarity Fund, the actively managed fund by Prudential, while Ecclesiastical Investment Management (EIM) will provide an ethical product. There will also be a Children's Isa Shariah model backed by Scottish Widows. The Shariah model invests in companies on the Dow Jones Islamic Stock Index with investments also screened through The Shariah Advisory Board.

Witan, which already has more investors under the age of five than over the age of 70, has also confirmed that it is to offer a junior Isa (JIsa) which will form part of the Jump range of children's saving options, sitting alongside its existing Jump Savings Plan for children and CTF. Investments will be made into Witan Investment Trust's multi-manager global portfolio.

UK financial services veteran Terry Smith's low-cost fund management company, Fundsmith, will be offering The Fundsmith Equity Fund Junior Isa. It will have a flat 1 per cent annual management charge, if bought direct, with a TER of 1.17 per cent, plus minimal trading costs due to Fundsmith's long-term buy-and-hold investment strategy.

The Fundsmith Isa will only be investing in the Fundsmith Equity Fund - the only equity fund Fundsmith says it will ever manage and the main vehicle for Mr Smith's own investments.

However, if you want choice and diversity it is important to choose a Junior Isa product that offers you access to a range of investment vehicles, including investment companies, actively managed funds and exchange-traded funds. For example, the Junior Isa offerings of Fidelity, Hargreaves Lansdown, Bestinvest and Alliance Trust will allow investment across the range of funds and shares available on these providers' respective platforms.

Fidelity's junior Isa will be run in exactly the same way as its Isa – all 1,200 funds from 70 fund providers will be available. Costs are competitive for those that get in early – there will be a 0 per cent initial charge across all funds for 45 days from 1 November. After the initial 45-day offer period, the initial charge will be 1 per cent, with the exception of the MoneyBuilder range, which is 0 per cent.

HL Vantage Junior Isa offers access to more than 3,000 funds, plus shares, exchange-traded funds, investment trusts, corporate bonds, gilts and a cash option. There are no account charges for investing in the majority of funds in the Junior Isa: the child pays a discounted initial charge, which is zero in the case of 2,400 funds and less than 1 per cent on almost all of the remainder. Annual management charges depend on the fund chosen and can vary from 0.25 per cent for an HSBC tracker to more than 2 per cent for multi-manager funds. For shares there is an account charge of 0.5 per cent capped at £45, so a child investing £3,600 would be charged £18 in the first year.

Alliance Trust Savings is another player that will have a junior Isa ready come 1 November. Investors will have access to the i.nvest platform which offers more than 1,400 funds, from over 40 UK fund managers; 4,000 UK equities and investment trusts as well as more than 21,000 international equities.

An added bonus is Alliance Trust Saving's 100 per cent fund commission rebate structure which could top up investment growth. Alliance Trust Savings rebates trail commission to the customer, which effectively reduces the amount of investment charges you pay. It reckons you could save £8,500 over 18 years (see table) compared with a provider that does pay trail commission to platforms. However, if trail commission payments generally decline after the end of next year - quite likely, given the big changes in how funds are marketed - the savings will be less.