Hello everyone! The Financial Wilderness is coming up to something quite special – our 1st birthday. I thought this would be good inspiration to talk about some of the options for if you’re looking to invest for your child, or where relatives would like to make gifts for their longer term future!
It’s been quite a whirl of a year. I’ve gone from a period at the start where it felt like I was writing only for myself and various friends I could badger into looking at the blog, to having quite a substantial following considering how long we’ve been going – thank you to all who’ve been here with me.
Should I invest for my child?
Yes, absolutely. In terms of setting them up for the future it really is one of the most effective things you can do. The reason for this is the magic of compounding really takes effect throughout the early stages of their life – by giving them a relatively small nest egg at a very young age this has time to build up into a large rolling snowball that can really make a difference to their life. It’s a gift that can keep on giving.
You can read more about how compounding works in our article on why investing works here – but basically it’s the cumulative effect of having gains from investments, then reinvesting those gains etc etc.
What should I consider when investing for my child?
There’s a number of different ways you can go about investing for children. What option is most effective and meets your needs depends on what you’re looking to do from a liquidity perspective and how comfortable you are with risk.
Let me elaborate on both points a little further:
Liquidity in this case means how accessible you want or need the money to be. Are you willing to take greater gains by locking up the money until they’re 18, or do you want them to able to access it through their childhood?
Risk is how variable the investments might be – how much they may go up and down in short term periods during the holding your investment. If you’re looking to hold money until they’re 18, you might want to think about accepting higher levels of risk as the investments will have time to recover and grow again after a down period. On the flip side, if you think your child might need their money at a very particular point in their life, there’s a danger you might need to withdraw during a “down” period in a higher risk portfolio.
The longer you are invested for, the more the downside risk is smoothed out. If you’re uncertain about what I mean by risk in practice, have a look at my article here on understanding your risk profile which will help provide some guidance on your tolerances.
How should I invest for my child?
Once you’ve worked out how you feel about your liquidity and risk preferences there a few options:
Cash Junior ISA – For if you are willing to lock away money until they are 18, and have a low risk tolerance.
Unlike Adult ISA’s which are still suffering from paying only rock-bottom rates right now, Child ISA’s actually offer a fairly generous interest rate and you don’t have to worry about being exposed to movements in the stock markets.
For those unfamiliar, an ISA is a tax wrapper designed by the Government to encourage saving. Financially it’s a better option than simply putting money into a bank account, because you don’t pay any tax on the interest you earn through savings.
When you’re setting this up, it’s worth doing some research on who is paying the best rate. At the time of writing (11.09.20) the best I’ve found is that you can get an interest rate of 3.25% with National Savings and Investments, fully guaranteed by the Government.
What you can’t do with this is take out the money early – so it’s not the best option if you’re looking to use funds during the teenage years.
If you’re looking for the high end of saving for your child as well, you’re limited to putting in £9,000 a year to the ISA from the next tax year.
Stocks and shares Junior ISA – for if you are happy to lock away money until age 18, and can accept some risk.
The stocks and shares version of the ISA works in a similar way with the cash one in terms of having the tax wrapper round it. In this case you don’t pay tax on the capital gain (so any money you’ve made from the investments going up).
The prime difference is that you introduce risk as the stock market return will be variable depending on the performance of the underlying companies. In exchange, you hope will provide a greater return for that additional risk. (Based on stock market history, this assumption generally holds as accurate).
With this approach, you can invest the money in whatever shares you like. The usual disclaimers apply here that anything on here is suggestion, not regulated financial advice, but when it’s a long term investment for a child, I would always suggest putting money in a low-cost tracker fund, which will largely replicate the stock market but won’t expose you to large-scale risk of individual companies having business problems.
With any investment there’s always risk of losing some money as much as gaining, but this keeps those risks sensibly managed. If you’re uncertain what you’re doing, always consult a regulated and reputable financial adviser. I definitely wouldn’t take the risk of trying to pick out individual shares yourself unless you’re a very experienced investor.
Can I split my Junior ISA between a Stocks and Shares Junior ISA and a Cash Junior ISA?
Yes, you can put money into both but the £9,000 overall limit applies to the sum total of money put into the ISA’s. So you can put £4,500 into a cash ISA and £4,500 into a Stocks and Shares ISA but not £9,000 into both.
A child easy-access savings account – for if you want them to be able access the money at any point, and to take no risk
A bit like the cash ISA, because banks want to try and turn you into lifetime customers the savings rates for children are actually pretty good – I was able to find examples paying a rate of 3.5% (oh to be young again!)
However they do tend to suffer from the same headache as adult accounts – that the bank offer a great introductory savings rate for a year, or offers a good interest rate between certain limits.
Ideally you want to look at terms and make sure you’re maximising the gain.
The real advantage that you have here is flexibility – if you’re looking to help fund them through the teenage years for example, this offers them a pool to dip in and out of, and is easy to set up.
The disadvantage is tax – if the money you pay in to the child’s account generates over £100 in interest in a tax year, this will be charged on your tax bill. That’s likely to be a smallish amount, but still something you should take into consideration.
A pension – for if you’re thinking really long term
Ok, this one is for the super planners amongst you – but one of the biggest financial issues out there is people not putting sufficient money aside for their pension.
As we harp on repeatedly here, the real benefit of investing is the way compound interest keeps rolling and rolling along – giving your child an extra 18 years of interest with a pension can really help them out in the very long term. This really is a long term commitment though, with them likely not able to access the money until they hit near-retirement.
You can only put in a maximum of £2,880 per year, but this gets added to in the form of a contribution from tax relief to make it a nice £3,600 (if you put in the full amount).
Premium Bonds – I’m not a fan, but For the Grandparents
Premium Bonds are popular at the moment, but I’m not entirely convinced they’re the best option here. They pay out at an average of 1.4% at the moment, which is better than many adult savings accounts but as we’ve already discussed above, there are ISA’s and saving account with better rates.
It’s important to note that you are also not guaranteed the 1.4% – premium bonds work with prizes being drawn at random which should average out to that – you may get a better or worse rate.
The advantage of premium bonds is that they can be gifted easily by grandparents or other relatives. In the case of some of the other options, there are sometimes restrictions to say that cash can only be paid in by parents, not wider relatives.
Beyond the lower payout rate than other options, my slight concern is that the Government is having a large push on premium bonds at the moment with lots more people taking them. I worry that given the average rate of interest is presently above many bank accounts, it may get cut as part of Government cost saving. I stress that’s pure speculation on my part, but I’d be wary.
Don’t forget to mix and match
Beyond where there’s limits on what you can put in, mixing and matching is entirely allowed and very sensible – so you can mix a longer term approach with an ISA alongside having a ready access pot for example. The best of both worlds!
And that’s it!
What this hopefully shows is that there’s a number of really good options for saving for your children, and it can really pay off for their future to take advantage of these schemes if you can afford to.
If you have further questions or think you have another good approach, please let me know in the comments below! I’d love to heard about any success stories as well.