Give your kids' cash a chance to grow
Children, especially babies, have one very important characteristic in common with the world's most sophisticated and successful investors.
They might not have vast amounts of money or understand how stockmarkets work but they do have time on their side. Because they can leave their money invested for very long periods of time - often up to 18 years or more - they can afford to take bigger risks in return for greater potential returns than their parents.
Investment trusts and funds/OEICs
Parents face a bewildering choice when it comes to selecting investment funds for their children's money.The first decision is between funds (also called open-ended investment companies or OEICs) and investment trusts. OEICs can create an unlimited number of units, the price of which goes up and down in line with the underlying assets. In contrast, investment trusts have a limited number of shares, the price of which goes up and down in line with demand, separate to the value of their underlying assets – referred to as the net asset value.
Mark Dampier, head of investment research for Hargreaves Lansdown, says: "Investment trusts have had a strong run over the past few years and many are trading at either a premium or at net asset value.They are not the bargain they were a few years ago, so beware past performance numbers."
For cautious investors, he suggests RIT Capital Partners Investment Trust, which has a mandate to preserve capital and stands at a discount of around 5%. "Newton Real Return does the same job in the OEIC world, and at the moment is very defensive with 20% in cash. However, I wouldn't consider either if I was investing for a time frame of 15 years or more," he says.
For parents prepared to take more risk, he suggests Woodford Equity Income, the fund recently launched by investment guru Neil Woodford. Dampier suggests reinvesting the income to benefit from compounding.
"You might also like to look at emerging markets, and Templeton would fit well here. It's a big liquid trust on a discount of about 10%, giving exposure to the rising middle classes in the undeveloped but faster-growing economies in the world," he says.
Parents who do opt for stockmarket-based investments do need to keep an eye on the time frame, especially if cash is needed for a specific purpose such as university fees.
Dampier says: "If you are lucky with timing and you have made good profits, you might want to look at selling up a year or so earlier than you need the money. Ideally, don't put yourself in the position that you have to sell just at a bad time in the markets."
Children benefit from their own personal income and capital gains allowances but to learn more about how to protect returns from tax.
Premium bonds are one of the UK's most popular ways to save, with £48 billion deposited in them. There's a good reason for this: they are run by National Savings & Investments (NS&I), a state-backed organisation, making them a very safe place to put money.You are guaranteed to get your original capital back.
However, rather than earning interest, your bonds are entered in a monthly draw for 1.84 million tax-free prizes ranging between £25 and £1 million, although you could win absolutely nothing.
Anyone over the age of 16 can buy them, and grandparents who want to buy them on behalf of their grandchildren can nominate the parents to hold them.The minimum holding is £100 but each person – including children – can hold up to £40,000 in premium bonds, and you can opt to have winnings reinvested.
Every bond has an equal chance of winning so the more you own, the better your chances of winning. NS&I started awarding two £1 million top prizes every month from August. Sadly, however, the annual prize fund interest rate is just 1.35% and the odds per £1 unit of winning any prize is 26,000 to 1.
For parents who are in the fortunate position to have adequate pension provision themselves, the next step could be to start funding their children's retirement, says Tom McPhail, pensions expert with independent financial service provider Hargreaves Lansdown.
"For the past 100 years, the standard of living and personal wealth has, in general, improved steadily. But we are now witnessing an unfortunate phenomenon where the adequacy of pension provision for generations to come slips backwards," he says.
"By investing in a pension so early, parents and grandparents can make a huge input to their children's retirement planning: the effects of compounding over such a long period of time can make a very big difference. It can also be hugely beneficial for inheritance tax planning, because it takes money out of your estate."
Up to £3,600, including £780 in tax relief, can be contributed to a child's pension each tax year. McPhail says the long investment term lends itself to an adventurous investment strategy, with equity income funds "the very least risk you should take" and emerging markets a reasonable option.
However, there is one big drawback to putting money into a pension for your child. Currently, pensions cannot be drawn until the age of 55 but this will rise to 57 in 2028 and then be linked 10 years below the state pension age, according to plans revealed by Chancellor
George Osborne in July.Those in their early twenties now will not be able to access their pension until age 60, and for babies the delay is likely to be even longer.
What the experts have chosen for their own children
Martin Bamford, chartered financial planner, managing director of Informed Choice and father to Megan, aged seven, says: "My daughter Megan has had a child trust fund from The Children's Mutual, to which her grandparents have contributed each year since she was born. In addition, she has a Fidelity investment fund portfolio, which her mum and I contribute towards on a monthly basis.This is specifically designed to pay for her university education.
"We take the very long-term view of investing when it comes to both of these, with the child trust fund invested in Invesco Perpetual Income fund and her Fidelity portfolio in First State Global Emerging Market Leaders. As she gets closer to her 18th birthday, we will gradually reduce the risk taken with both of these accounts, moving them into cash closer to the time she needs to use the money for education or other purposes.
"She also has a cash savings account, which is funded on a less regular basis."
Patrick Connolly, certified financial planner with independent financial adviser Chase de Vere and father to Aidan, aged 12, says: "I save into a Junior Isa for Aidan, monthly premiums into the Jump savings plan which invests in the Witan Investment Trust.There isn't a particular reason for saving other than for his future. I hope he goes to university and, if so, the money can be used to help him with that. If he doesn't, then it can be used for another purpose.
"I chose the Witan Investment Trust because this is a diversified global equity fund which I ideally want to hold for him for the long term without having to chop and change. I'm not looking for a fund that will shoot the lights out but rather one that will produce consistent long-term returns."
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
A form of National Savings Certificate, premium bonds are effectively gilt-edged securities: you loan your money to the government and, in return, it pays you for the privilege with a guarantee it will return your capital at a specified date. Where premium bonds differ is that the interest payments (currently 1.5%) are pooled and paid out as prize money and you can get your cash back within a fortnight, with no risk. Launched by Chancellor of the Exchequer Harold Macmillan in his 1956 Budget, every single £1 unit has the same chance of winning and in May 2011, 1,772,482 winners (from a total draw of 42,539,589,993 eligible bond numbers) shared £53,174,500. The odds of winning are 24,000 to 1 and the maximum holding is £30,000 per person but it remains the only punt in which you can perpetually recycle your stake money.
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.