Ian is 44 and has been investing for 15 years. He wants to build a nest egg for his two young children, aged 20 months and one month, using junior individual savings accounts (Junior Isas).
He says: "I'm fairly open to risk as it's a long term, 18-year investment. I'm investing on behalf of my children so want to make sure I've made the right decisions for them.
"My personal last three trades were to take some of the tips from Investors Chronicle - Arbuthnot Banking (ARBB), Johnson Service (JSG) and Crest Nicholson (CRST). I'm considering switching some actively managed funds into exchange traded funds (ETFs) and potentially converting some of my poorly performing unit trusts into further IC share tips.
"However, for my children I'm wondering if I should switch the capital into ETFs and use the monthly regular investments to drip feed into unit trusts. I'm also interested to know how I should develop the investment strategy as the funds grow over time."
Nest egg for children
Ian's son (aged 20 months)
Currently investing £50 per calendar month into Newton Global Higher Income.
|Name of holding||Number of shares/units held||Price||Value||%|
|First State Global Emerging Markets Leaders (GB0033873919)||118||448.03p||£528||23|
|Marlborough Special Situations (GB00B659XQ05)||56||1046.46p||£586||25|
|Newton Global Higher Income (GB00B7S9KM94)||909||131.69p||£1,197||52|
Source: Investors Chronicle. Price and value as at 15 March 2015
Ian's daughter (aged one month)
Initial deposit of £1,000 with £50 per calendar month thereafter.
Moira O'Neill, personal finance editor at Investors Chronicle, says:
When investing for children, there are three key points to consider:
1. Fully fund your own individual savings account (Isa) and pension first. There is no point having separate Junior Isas for children if you haven't got your own long-term investments under control.
2. Make sure you have a 'saving for children' conversation with all family members. Can grandparents contribute? Many want to but don't want to broach the subject and are waiting for you to bring it up first.
3. Grandparents may wish to consider a pension for their grandchild(ren) rather than a Junior Isa as this is the most tax-efficient vehicle and leaves the longest legacy.
ABOUT JUNIOR ISAS
Junior Isas are long term, tax-free savings accounts for children. In the 2014 to 2015 tax year, the savings limit for Junior Isas is £4,000. In a stocks and shares Junior Isa you won't pay tax on any capital growth or dividends you receive.
Your child can have a Junior Isa if they are under 18 and live in the UK. Parents or guardians with parental responsibility can open a Junior Isa and manage the account, but the money belongs to the child. The child can take control of the account when they're 16, but can't withdraw the money until they turn 18.
You can't open a Junior Isa if you already have a Child Trust Fund. However, from 6 April Child Trust Funds can be transferred to Junior Isas.
YOUR 18-YEAR TIMESCALE
Chris Dillow, Investors Chronicle's economist, says:
You have an 18-year time horizon, which poses the question: what do we know about what will happen in these 18 years?
One fair bet is that we'll see creative destruction. As economist Joseph Schumpeter famously pointed out, economic growth is a disruptive process: it destroys incumbent companies while a lot of future prosperity will come from companies that don't yet exist.
This means that long-term investing in specific stocks is dangerous, because stocks might be on the wrong side of technical change: you might find yourself investing in Polaroid rather than Apple. I've estimated - based on the fate of the original members of the FTSE 100 - that there's around a 0.3 per cent chance each year of the average FTSE 100 company going bust. Over 18 years, this implies that we should expect around five current FTSE 100 shares to collapse.
You might think you can overcome this risk by regular trading. But that's expensive. And it presumes a degree of foresight even about the near term which you might not possess.
There's something else we know - the power of compounding. Compounding, though, isn't just great for investors. It's also great for fund managers. An annual fee of 0.75 per cent - the difference between a cheapish actively managed fund and a tracker - could easily mean that over 18 years you would lose £300 per £1,000 of original investment.
This argues against investing in actively managed funds. Over a period as long as 18 years we cannot be at all confident that a fund manager's stockpicking skill will persist or that he will remain with his fund if it does. But we can be confident the fund will continue to charge high fees.
There's more that we don't know but which are fair bets. It's reasonable to suppose that the economy will grow to some extent and that, over the long run, wages and profits will grow at around the same rates. The latter is by no means guaranteed - distribution risk does matter - but it was a "stylized fact" about growth proposed by Nicholas Kaldor in 1957 and it has been roughly true since then, barring a fall in the profit share in the 70s and recovery thereafter.
These presuppositions allow us a rough estimate of total equity returns. If we assume (cautiously) that the real economy grows by 1.5 per cent a year, that stock market valuations don't change, that profits also grow at this rate and that dividends rise at the same rate as profits, then we should see real total returns on equities of around 5 per cent per year: 1.5 per cent capital growth and a dividend yield of 3.5 per cent. This means that an investment of £600 per year should give your children around £15,500 in today's money when they are 18.
So, how can you capture this 5 per cent? First, you must minimise the risk from creative destruction. This means investing in funds, not specific companies. Secondly, it means minimising fees, so the returns go to you and not the fund manager. This argues for tracker funds: exchange traded funds (ETFs) or unit trusts. Thirdly, it means you must reinvest the dividends: these will probably account for most returns over the long run.
This advice might sound very dull. But there's a trade-off between effectiveness and excitement. If you want the latter, why not just gamble all your children's money on the 3.30 at Haydock Park?
Amanda Tovey, investment manager and head of direct equity at Whitechurch Securities, says:
At the moment the portfolios are small and higher risk being completely invested in equities but have an 18-year minimum time horizon. Currently there is a good geographical spread of equities through the three funds used with exposure to developed market income producing equities, emerging markets and also mid- and small-cap UK through the Marlborough Special Situations fund (GB00B659XQ05).
ETFs would certainly reduce the overall cost of the portfolio in the long term (dependent on platform used) if current investments were switched and global large-cap exposure could be achieved through the use of one global or several regional ETFs as could emerging markets exposure. However, the small- and mid-cap UK exposure provided by Marlborough would be more difficult to replicate although ETFs are available in this area.
When considering a switch to ETFs or direct equities thought needs to be given to fees and charges. Some platforms charge inactivity fees or very high dealing fees for infrequent trading, so while you may think you are paying less because there are no underlying fund charges you can get caught out in other ways.
If you are considering moving into direct equities thought needs to be given to diversity and asset allocation. If you are happy to hold entirely UK shares, generally 15-20 stocks are considered to be enough to diversify away stock-specific risk but you need to ensure that the amounts held in each share are enough to make sure trading costs are reasonable in relation to it. Within the portfolio you also need to consider sector spread and size of company spread, having a high concentration of stocks in one sector increases risk and if investing in small-cap shares liquidity and spread needs to be considered.
If you want to have overseas exposure through direct equity you need to think carefully about exchange rate risk, increased costs of dealing for overseas shares, information available on the stock and also tax and administration requirements - eg, to hold US direct equities a W8BEN form has to be completed each year for tax purposes.
Given that the overall aim is long-term growth the portfolio needs to be diversified but without creating over-diversification, each holding needs to be a meaningful percentage of the portfolio. Overall asset allocation also needs to be considered in terms of risk profile.
Moira O'Neill says:
In terms of ideas for Junior Isa investments, earlier this month Jason Hollands of Tilney Bestinvest recently recommended Scottish Mortgage Investment Trust (SMT) and Artemis Strategic Assets fund (GB00B3VDD431). You can read about this here. You can also listen to him talking about these funds and investing for children in general on Investors Chronicle's Isa special personal finance podcast which you can find at: https://soundcloud.com/investors-chronicle
However, I understand the appeal of passive investing when building a nest egg for your children rather than yourself. It is harder to risk underperforming the market when you are investing on someone else's behalf.
Exchange traded funds (ETFs) and open-ended tracker funds will both do the job of tracking the market and reducing your overall costs. However, investors who are buying small amounts on a regular basis may prefer tracker funds over ETFs because of the broker fee that their online platform may charge when buying an ETF.
For low-cost ETF exposure, you could consider the iShares Core ETF Series.
For cheap ranges of tracker funds try Fidelity and Vanguard.
HSBC FTSE 250 Index Fund (GB00B80QG052) could be a good fund to hold for children over the long term, because it contains more young and growing UK companies than the FTSE 100. It comes with an annual charge of just 0.17 per cent and is higher up the risk scale, but the index has outperformed the FTSE 100 and FTSE All-Share substantially over the past 10 years.
As your portfolio grows in value, the trick will be to rebalance it every year in line with your chosen asset allocation.
•None of the above should be regarded as advice. It is general information based on a snapshot of the reader's circumstances.