Should my children avoid student debt or invest?

James has two children aged 18 and one aged 16. The two older ones each have a Child Trust Fund (CTF) which has recently matured so should have become an individual savings account (Isa). The two accounts have the same holdings and values. The 16 year old has a CTF.

The two oldest children have recently finished school and are taking gap years before they start university next year. They are doing work experience and do not need to draw from their holdings yet. They have no other income or assets.

“One of my 18 year olds is financially minded, wants to earn decent money and is interested in managing her portfolio,” says James. “She has no experience of doing this, although has a long-term perspective. She hopes to go into a high-earning profession and intends to take out her full student loan entitlement in the hope that the investment returns of her Isa will be higher than student loan interest. She hopes to use the money as a deposit to buy a home.  

"My other 18 year old is more relaxed, and not interested in investing and  earning a high salary. She is likely to go into farming so will be a low-rate taxpayer. She also plans to take out her full student loan entitlement, as she is unlikely to ever have to pay it back, so doesn't plan to draw on her investments while at university. She might invest her Isa savings in a farm.

"My 16 year old is at school and not interested in investing, although would like to use the money in her CTF for a house deposit.

"I agree that they should leave their holdings untouched while they are at university and take out loans. The Isas and CTF are currently held with BMO. I think this is sensible as the investments it offers for these accounts is a range of investment trusts, meaning that they cannot invest in anything too mad until they have a bit more experience. They can adjust their holdings within the available options to get experience of making choices based on past performance and future possibilities.

"That said, I want them to take a greater interest in investing and first direct offers a reasonably priced investment service linked to a bank account, although it does not offer investment advice. Alternately, investment platforms such as interactive investor, which I use, offer a wide choice of investments but I don’t think it is suitable for teenagers.

"Some online wealth managers, such as Nutmeg, allow you to invest via an app, so might be suitable for young people. But, ideally, I would like them to take some responsibility for their holdings and have a sense of ownership.

"I thought a good option could be to keep their main holdings somewhere traditional and give them some ‘play’ money with which to get a feel for investing. I am thinking of putting a small amount of money for each of my children into an account which allows them to trade via an app, so that they can learn about how the market moves and making choices.

"I also wondered what holdings would be suitable, depending on whether they are seeking income or capital gains?"

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.

James Norrington, associate editor at Investors Chronicle, says:

The benefit of your experience is important in helping them choose providers, but there are a few main considerations. The first is how secure the funds are going to be and if they are covered by the UK Financial Services Compensation Scheme (FSCS) – which is the case with most of those offered by the main UK investment platforms.

The second issue is choice of investments and, again, the main providers’ offerings are more than adequate for your daughters’ needs.

A third and very important factor is costs. Over time platform fees can compound and be a serious drag on investment performance. Some of the biggest platforms charge onerous administration fees just for holding mutual funds.

But interactive investor has a flat and transparent charging structure for all types of investments, so would be among the better choices for your daughters.

You’ve already helped your kids take advantage of time. By being invested so young they benefit from compounding of returns. I don’t think you should worry too much about their platform making it easy for them to be super involved. It’s most important that the funds are secure and safe from hackers, and the platform isn’t ripping them off.

Financial education is vitally important, and platforms should be user-friendly and help people understand what’s going on with their investments. That said, some of the new generation of investing apps are too much like computer games and encourage people to whip in and out of investments on animal spirits. And one of the worst things investors can do is over trade, as it heaps up charges and leads to investing mistakes because emotions get involved. Investors who do this also tend to miss out on early rally upside.

As long as your children stay invested and reinvest dividends and coupons, they should do very well. So I’d be agnostic about whether they have growth or income holdings – rather, the focus should be total returns. The power of compounding over time is by far the best way for investors to make money, so the fact that some of your children are not interested in investing is no handicap.

In keeping with the staying invested mantra, your children would be better off leaving their portfolios to accumulate rather than drawing from them to pay for university. Student loans are psychologically off-putting, but are a much better way to pay for higher education. An investment portfolio is something your children own rather than something they owe.

And student debt only has to be paid back if you earn enough – it’s effectively a graduate tax at a percentage of salary. The choice is between having no investment pot at the end of university, so no house deposits and paying rent for longer, and an annual tax that is capped at a percentage of salary. Inflation may add to the interest at which the loan accrues, but this may be capped if it becomes vastly out of kilter with commercial loans.

Jessica Ayres, financial consultant at Timothy James & Partners, says:

Student loans are a good option as they are repaid at a rate of 9 per cent of earnings above £2,274 per calendar month. Low earners may pay little or nothing back as the debt is erased after 30 years. Choosing to clear the debt is not necessarily best for those earning above the threshold. See moneysavingexpert.com for straightforward information on this.

Ensure that the matured CTFs have converted to Isas. This is not always an automatic process and a positive election may be required.

Isas provide a tax-free investment environment, are accessible and allow tax-free withdrawals. So the child who is considering a career in farming, for example, could use the funds within her's as required.

Converting the 16-year-old’s CTF to a junior Isa may offer better investment choice and value, as these can offer higher interest rates on cash and lower fund management charges. You cannot hold a CTF and Jisa at the same time, so she would need to convert rather than have both.

When a child reaches age 18 their junior Isa converts to an adult Isa. At this point, a Lifetime Isa could be a good option as it enables you to save up to £4,000 a year towards a first property. The government adds a bonus worth 25 per cent of what is saved in each year, up to a maximum of £1,000, as long as it is used to buy a first home or invested until age 60.

Using an Isa to fund a lifetime Isa would meet your childrens' objective of purchasing a property while maintaining the tax-free status. The remaining Isa funds could be invested for long-term growth and the lifetime Isa could be held in cash. An effective 25 per cent return on cash is fantastic in today’s low interest rate environment. But note restrictions, such as the property the lifetime Isa is used for having to cost £450,000 or less, or your children will lose the government bonus. You can find further information on this at https://www.gov.uk/lifetime-isa.

BMO offers the types of Isas mentioned above, its website is easy to navigate and its charging structure is competitive. But I would move to another provider to try to get better investment performance. 

interactive investor and first direct do not offer all the types of Isa mentioned above, but there are many apps that do. Moneybox, for example, is highly rated and cost effective. It allows transfers from Isas to lifetime Isas. Its beginner investment option offers cash with an annual equivalent rate of 0.85 per cent. It also offers cautious, balanced and adventurous portfolios which could help your children gain investment experience. Or they could self select Isa funds.

The child who wishes to make returns higher than student loan interest would need to invest in Moneybox's growth portfolio or self-select a range of global equity funds within her Isa. But seeking higher returns comes with higher risk.