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What are the best investments for giving our son a good start in life?

These investors want to grow their son's investments to give him a good financial start to adult life
April 1, 2022 and Robert Ward
  • These investors want to grow their son's investments to give him a good financial start to adult life
  • They should explain to him what the purpose of the investments in his Jisa in the years leading up to his 18th birthday
  • Passive tracker funds could be a good low-cost way to invest over the long term
Reader Portfolio
Jack 12
Description

Jisa, Junior Sipp and investment account invested in funds, cash

Objectives

Grow savings and investments to put child in a strong financial position when he becomes an adult, add to Jisa and Junior Sipp each year, continue to invest for child after age 18, pass assets to child tax efficiently.

Portfolio type
Investing for children

Jack is age 12. His parents and grandparents want to give him a good start in adult life and continue to support him, so are building up savings and investments. After he was born, his parents invested the £250 the government gave children at the time to start a Child Trust Fund. Since then, they have invested the maximum amount possible into this account each year, which they have transferred into a junior individual savings account (Jisa). They already fully use each of their own annual individual savings account (Isa) allowances.

“We plan to add to Jack’s Jisa each year until he is 18,” says his Dad. “Then, depending on whether he is still in education or an apprenticeship, or has started work, we will continue to invest for him in an adult Isa, Lifetime Isa or both.

“We also opened a junior self-invested personal pension (Sipp) for Jack soon after he was born and put £2,880 into this each year, so £3,600 with tax relief. We plan to do this until Jack has an income and can manage the Sipp himself. This has a value of around £77,000.

“I no longer pay into my own pension as its value has breached the lifetime allowance limit, but we do put £2,880 a year – £3,600 with tax relief – into my wife's pension.

"Our home has a value of about £375,000 and two years ago, we remortgaged it on a 10-year term fixed rate of 2.49 per cent. We borrowed £200,000 which we invested in an investment account for Jack. My wife doesn’t currently work, but I earn £80,000 a year and as we don’t have large material aspirations apart from family holidays, we want to give Jack his inheritance early in his adult life. We also hope that by doing this the gift won't incur inheritance tax (IHT). Jack’s investment account now has a value of about £239,000 and there is an outstanding mortgage on our home of about £175,000.

"Jack’s grandparents have invested £25,000 in a building society bond for him. And we expect them to leave him a small, rental property which is valued at around £120,000, is mortgage free, and generates rent of about £500 per month. If they have not specified this in their wills we will pass on the property to Jack via a deed of variation.

"We have invested Jack’s Jisa, Sipp and investment account in high risk, potentially high return investments as it is likely to be a fairly long time before he draws from them. These are largely invested in global equities, UK smaller companies and private equity funds, and also have some exposure to technology, healthcare and European equities. We try to avoid investing in Chinese and Russian stocks, though this can be difficult to do if you hold global funds.

"Do we have the right mix of investments and risk level? And would the portfolios, which are largely invested in active funds, be better off in low-cost tracker funds, which would also reduce the amount of time we spend managing them?

"And how should we change our investment approach when Jack turns 18 and or finishes his education?"

 

 

Jack's investment portfolio
HoldingValue (£)% of the portfolio
abrdn UK Smaller Companies Growth Trust (AUSC)55,32215.97
F&C Investment Trust (FCIT)55,00015.88
Legal & General International Index (GB00BG0QP604)*41,86312.09
Henderson Smaller Companies Investment Trust (HSL)38,98411.25
JPMorgan Mid Cap Investment Trust (JMF)33,0339.54
Herald Investment Trust (HRI)26,0007.51
Building Society bond25,0007.22
Royal London Sustainable World (GB00B882H241)20,1515.82
Bellevue Healthcare Trust (BBH)11,0003.18
Fidelity European Trust (FEV)*7,3932.13
HgCapital Trust (HGT)*4,9481.43
HarbourVest Global Private Equity (HVPE)*4,7661.38
Pantheon International (PIN)*4,7371.37
Impax Environmental Markets (IEM)*4,7001.36
Montanaro European Smaller Companies Trust (MTE)*4,6241.33
NB Private Equity Partners (NBPE)*4,4651.29
JPMorgan US Smaller Companies Investment Trust (JUSC)*4,4091.27
Total346,395 

*Isa holdings

 

Jack's £77,003 Sipp allocation

[insert pie chart]

 

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

 

Chris Dillow, Investors' Chronicle's economist, says:

Jack won’t need this money for at least six years so you have a long investment time horizon. But resist the temptation to pile into 'growth' sectors such as healthcare and technology. Expected growth should be embedded in their share prices by now so you pay a premium for stocks focused on these areas. This means that growth in itself does not necessarily result in great returns for these. Rather, companies that deliver more growth than expected give you good returns. And these can come from anywhere. For example, although UK tech stocks have done well in the past 10 years, so too have less glamorous sectors such as insurance and support services.

There’s a risk that growth sectors will do very badly if growth appears to be falling short of expectations. If this happens valuations will fall and this can cause losses, even over very long periods. Japan’s Nikkei index is still lower than it was in 1989, and even the Nasdaq index did not return to its 2000 high until 2015. In this sense, long-term investing is risky.

Research by Hendrik Bessembinder, professor of competitive business at Arizona State University, shows that most stocks underperform cash during the time they are listed on public markets – another problem for long-term investors. The global equity market’s long-term returns are thanks to only a handful of fantastic performers such as Apple (US:AAPL) and Amazon.com (US:AMZN). This reflects well on the economy – in well functioning competitive markets high profits should be only temporary. But it means that if you miss out on the few great performers of the future, which might not be today’s successful companies, you will underperform the market.

Because of the valuation risk growth stocks face and the difficulty in picking the few long-term winners, longer-term investors should hold passive tracker funds. These protect against being overweight in stocks whose valuations are falling or underweight in the minority of stellar performers.

But tracker funds also have risks. Over the next 10 years the investment environment will change in ways we cannot predict. What we can say, though, is that there is a non trivial risk of losses even over long periods. If past risks and returns are a guide to the future, there’s around a 10 per cent chance of global equities being lower in real terms than they are today.

You might think that this risk is worth taking because there is a much higher chance that assets such as cash and bonds will make negative real returns. And even if global equities are lower in real terms than they are today, Jack will still start his adult life in a great financial position – you’ll be more disappointed than him. Just be aware of this risk.

It is sensible to invest in private equity. It’s quite likely that a lot of future growth will come from companies that aren’t yet listed on stock markets. Some investors avoid private equity funds which offer exposure to such growth because they don’t like that these investments are illiquid. With private equity investment trusts, this results in big discounts to net asset value during difficult periods. However, longer-term investors like yourselves can afford to take on liquidity risk so you should be rewarded for doing something that other investors cannot.

 

Robert Ward, chartered wealth manager at Walker Crips Wealth Management, says:

On the whole, the approach and investments you are using to give Jack a good financial future are largely what you would expect to see and make good use of the tax-efficient options available.

I always ask investors in similar situations when they think would be the worst time in life to receive a large lump sum of money. They nearly always reply “at 18 or 21 years old”. And the Junior Isa will transfer to Jack when he turns 18, at which point he will have full control of and access to the money within it. So it would be prudent to involve Jack in conversations about his investments in the years leading up to his 18th birthday, to increase his understanding of them and their objectives.

The Sipp is less of a concern because Jack can't access this without large penalties at least until he is age 57.

If the remaining part of Jack's portfolio is in one or both of your names, regardless of whether the funds are earmarked for Jack, they are still your investments and will remain under your control until you pass them to him in an account in his own name. The transfer of shares, as opposed to sale and gifting, has the potential to trigger a capital gains tax (CGT) charge if they have made gains in excess of your annual CGT allowance. So the timing of the transfers will be important to manage this liability. You could transfer chunks of this account to Jack over multiple tax years to reduce potential tax liabilities.

Also, if you hold these investments in an account in your own names, they form part of your estates for IHT purposes. They will not fully fall outside your estates for seven years after you have given them Jack.

You have some excellent exposure to long-term investment themes such as technology, smaller companies and healthcare, which we wholeheartedly endorse for long-term growth. Other themes worth considering include artificial intelligence and future transport, which you could get exposure to via low-cost tracker funds. You currently hold some investment trusts with expensive ongoing costs which can have a very detrimental impact on their returns over the long term.

You are attempting to avoid investing in countries such as China and Russia. If you and or Jack feel strongly about this and other ethical issues, or think that in years to come he may take issue with the way in which his wealth has been generated, consider tilting the portfolio further towards an ethical stance. Compared with even only a few years ago, there are many ethical funds available the increase in which has been particularly rapid over the past two years since the outbreak of the pandemic.