University fees, first car, mortgage deposit or a gap year spent travelling around the world – whatever your child ends up doing when they grow up it's going to cost plenty of money.
One way to take some of the pain out of these future bills is with an investment strategy. As long as you've got more than five years to spare, putting your money into stockmarket-based investments is worth considering.
"You can take advantage of the potentially higher returns available through riskier investments such as equities, compared with the poor returns currently available on cash," says Lee Smythe, managing director of Killik Chartered Financial Planners. "But switch into less risky assets as the event you're investing for approaches."
With time on your side, you can afford to take more risk with your child's investments, so you should look for funds that have a global or emerging market presence, says Andy Parsons, advice team manager at The Share Centre.
To support his view on emerging markets he points to the performance of the MSCI Emerging Markets Index compared with that of the FTSE 100.
Over a 10-year period to 29 July 2010, while the FTSE 100 increased by 18.05%, the MSCI Emerging Markets Index grew by 187.29%.
While you could invest in individual shares on behalf of a child, one of the best ways to invest is through a collective investment such as a unit trust, open-ended investment company (OEIC) or investment trust.
This is because your money is spread across a number of shares, reducing the risk of losing it all.
Choices, choices
There are more than 2,000 such funds to choose from, ranging from funds investing in UK blue chips or gilts (government bonds) and corporate bonds, through to emerging markets and technology.
You'll pay an initial charge when you invest in unit trusts and OEICs, which could be up to 6%, plus there's an annual charge of up to 1.75%.
However, while investment trusts are bought through stockbrokers, you can buy and sell unit trusts and OEICs direct or through a discount broker or fund supermarket – where you'll benefit from heavily reduced initial charges.
Friendly society bonds are another equity-based product that can be packaged for children. These allow you to invest £25 a month or £270 a year and, providing you invest for at least 10 years, the proceeds will be tax-free.
But many financial advisers are sceptical about friendly society bonds. "We don't recommend them," says Patrick Connolly, spokesperson for AWD Chase de Vere. "These products typically have high charges, are inflexible and perform poorly."
You can even take out a pension on your child's behalf, taking advantage of the annual pension contribution of £3,600 gross.
"The money won't be available until they reach at least 55 under the current rules, but contributions benefit from 20% tax relief at source, meaning each £80 saved becomes £100 – an instant return of 25%," says Smythe.
Tying your child's money up in a pension until they're 55-plus may seem a harsh idea, but it does get round the issue of whether or not they'll squander their money once they get their hands on it.
With all the other forms of investment, however, you can invest through either a designated account (in your name but with your child's initials attached) or a bare trust in the child's name – which means they'll be entitled to the money when they reach age 18.
Plumping for the bare trust option has tax benefits. If you hold the investment in a designated account it's taxed as your investment, while putting it in a bare trust means, unless it generates more than £100 of income from money from a parent, it's taxed as the child's.
But Smythe recommends keeping investments in your name: "If you invest in the child's name, they are entitled to it at 18. I'd always urge parents to invest in their own name, so they have the funds available either as a gift for their children, or to use as and when they think appropriate."
Fund recommendations
Andy Parsons, advice team manager at The Share Centre, recommends global, diversified emerging market or concentrated emerging market exposure, tipping M&G Global Basics, Aberdeen Emerging Markets and Allianz RMC BRIC Stars.
Patrick Connolly, spokesperson for AWD Chase de Vere, recommends M&G for investments for children. "M&G allows investments from as little as £10 a month," he explains.
"We like M&G Global Basics, M&G Global Leaders and M&G Global Growth. They're consistent performers and well diversified internationally."
Lee Smythe, managing director of Killik Chartered Financial Planners, says: "I'd recommend the Troy Asset Management Trojan fund and the Artemis Strategic Assets funds for broad-based exposure across a number of asset classes."
Additionally, for those who want to make a more speculative long-term equity investment, he suggests Lazard Emerging Markets fund and the First State Asia Pacific Leaders fund.
OEICS
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).
Stockmarket
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Unit trust
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.
Investment trust
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.
FTSE 100
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Emerging markets
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.
Equities
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
BRIC
An acronym, which stands for Brazil, Russia, India and China; countries all deemed to be at a similar stage of advanced economic development. The term was coined in 2001 in a report written by Goldman Sachs director Jim O’Neill who speculated that, by 2050, these four economies would be wealthier than most of the current major G7 economic powers.
Gilts
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
