Consider investment trusts for your child's finances
Most parents would like to give their children a bit of a financial head start when it's time to go to university, buy their first jalopy or invest in a starter home.
Goodness knows, young people need all the help they can get these days: the National Union of Students (NUS) estimates that students finishing three-year degree courses this summer will start their working lives (if they can find a job) with an average £23,500 millstone hanging around their necks.
Meanwhile, although house prices are still around 15% down from the peak levels of mid-2007, the average deposit needed by a first-time buyer stands at a crippling £34,000 – more than their total gross household income, according to the Council of Mortgage Lenders.
The credit crunch ensured that 100% mortgages, which once made it possible for first-time buyers to sidestep the need for deposits as long as they could meet the monthly payments, have simply dried up.
And there's no sign of them returning at present either; indeed, very few lenders even offer 90% loans to first timers.
So, parents – not to mention grandparents and any other sympathetic relatives – are under growing pressure to make some kind of provision for the next generation.
Regular savings advantage
If you start when your baby is born, time is on your side. And that's where investment trust regular savings schemes could save the day.
As Justin Modray, director of the financial website candidmoney.com, observes, these schemes have several key strengths that make them ideal for building up a substantial sum over the very long term - maybe 18 years or more if you're particularly organised and plan in advance.
"It's a great deal easier to set up a direct debit straight from your monthly income and see the funds automatically transferred over the months, than to try and save up enough for a lump sum investment, with the temptation to 'borrow' from your earmarked cash always hanging over you," says Modray.
However, there's nothing to stop you adding the occasional lump sum to your savings scheme as well, if you're ever in the money.
Even if you have little to spare, regular savings schemes can be manageable for you. Many allow you to put in £50 or less every month. Some of the investment trusts offering children's savings schemes will accept as little as £25 a month.
Yet £25 a month over 18 years amounts to £5,400 of capital, and that is without the capital growth generated by your money over the years.
One key attraction of regular saving into a unit trust or investment trust is the effect of what's known as 'pound-cost averaging'.
When share prices are rising, your monthly contributions buy progressively fewer units of investment; but you're also buying as the market falls and share prices get ever cheaper, so your cash buys progressively more.
At the bottom of the market, your money is still being regularly invested – and those same contributions buy sackloads of units.
"The extra units your contributions have bought during the bear market boost the size of your investment and therefore set you up to do well when the market eventually recovers.
"As a result, the average price you've paid per unit can be lower than the straight average of the investment price over that same period," says Modray.
Pound-cost averaging works most effectively when the market is yoyo-ing and you're getting regular opportunities to buy relatively cheaply.
The next big question is what kind of account or investment to use. Again, when you have a very long timeframe, more options are open to you.
Over 10 years or more, you would be advised by any financial adviser to put your money into the stockmarket rather than into the security of a bank savings account.
The figures speak for themselves. Morningstar data for 18 years to the end of July 2010 shows that a £100 lump sum invested in the average savings account would have grown by 43% over that time.
But that same cash in the average UK All Companies unit trust would be up by 323% over that time – and in the average UK Growth investment trust it would have gained over 513%.
So, could an investment trust savings scheme be the way forward? Certainly in terms of performance it's a good choice.
Investment trusts tend to outperform unit trusts over the long term, partly because their internal charges are generally lower, but also because (unlike unit trusts) they can borrow to increase returns.
However, they are also more volatile investments than unit trusts, because of their structure. That's not something to be frightened of, but it's essential to understand what it means and be prepared to invest for the long term.
Investment trust children's savings plans have other advantages for cash-strapped parents.
First, dealing charges are very low. In these plans, the scheme administrator places all the investments for one month as a single bulk deal with a stockbroker.
It's worth pointing out that one exception to that low-cost rule is the Alliance Trust Savings scheme.
Although it is unique among these schemes in that investors have the full range of stockmarket investments, including investment trusts, to choose from, the plan charges a flat £5 per deal on regular savings apart from those going into shares in Alliance Trust itself (which has no purchase charges).
On a £50 monthly contribution, for instance, that would amount to a hefty 10% of your monthly investment siphoned off in fees.
A second benefit is that most plans give access to a good range of trusts run by that management team.
For example, using Aberdeen's plan you can invest into trusts ranging from Aberdeen Asian Smaller Companies and Aberdeen New Dawn to Murray Income Trust. You can choose as many different trusts as you want within the plan too.
Best choices for children
What, then, are good choices for this kind of investment? Traditionally, some of the most popular trusts for investors with an eye on the kids' future have been the big, steady, global growth giants offering savings schemes, such as Witan and F&C Investment Trust.
They're reliable and very well diversified (some of these trusts have hundreds of holdings) – but they're not going to set anyone's portfolio on fire.
For example, over the past 18 years to end July 2010, the F&C Investment Trust share price has risen by 250%. While it's not to be sniffed at, nor is it anything special, given that the average global growth investment trust has risen by 526% over the same period.
There's a strong argument made by a number of advisers that if you have the kind of timeframe enjoyed by young parents, it's an excellent opportunity to tap into some of the biggest growth themes of today's world – natural resources, the rise of emerging markets and the environment.
Of course, these trusts involve more risk, because they are more focused on a particular 'theme' or region: if things go wrong there, they will feel the impact more than a more diverse, globally invested trust would.
Moreover, where there's relatively rapid growth, there are almost bound to be more difficult periods when your investment does less well or even loses money over the short term.
But as we've seen already, the effect of pound-cost averaging means such periods are much less painful for regular investors.
If you believe in the long-term significance of the underlying investment theme, pick your trust carefully and are prepared to weather the ups and downs without panicking, you're very likely to see the difference at the end.
To put that into context, let's look at long-term performance of some top trusts operating in these 'racier' markets.
Aberdeen New Dawn is up almost 700% over 18 years; Templeton Emerging Markets has gained nearly 800%, and BlackRock World Mining has achieved over 600% in the 15 years plus of its existence.
Remember, although it is possible to tap into certain top emerging markets trusts through some of the kids' savings plans, many other management companies offer straightforward 'non-child-specific' regular savings schemes – and these work equally well for a child's investment, provided you can afford the minimum monthly contribution which tends to be higher.
The other issue to consider, regardless of your investment choice, is how to hold the shares on behalf of your child. Children under 18 cannot own investments in their name, but there are ways to get around this.
One is to create a 'designated' account, set up in your own name but with the child's initials included as well, to show whom the money is intended for. You remain in control and can decide when to hand over the investment – but you'll also be taxed on any gains.
The alternative is to set up a 'bare trust' with the child as the beneficiary and you as trustee (to look after the fund in the meantime).
This way, you don't have to pay tax on the gains – but the downside is that the investment belongs to the child from the age of 18, and there's nothing the trustees can do to prevent that.
If you're unsure how best to arrange things, take professional advice. Meanwhile, remember – slow and steady saving now could produce results that transform your child's life in years to come.
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
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.
This refers to a market situation in which the prices of securities are falling and widespread pessimism causes the negative sentiment to be self-perpetuating. As investors anticipate losses in a bear market and selling continues, pessimism grows. A bear market should not be confused with a correction, which is a short-term trend of less than two months. A bear market is the opposite of a bull market.
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.