The first children to qualify for the Government's child trust fund (CTF) scheme will be turning five years old today, and already there are some big differences in the amount of money in their piggy banks.
According to BestInvest, the London-based financial advisers, the very best CTF funds have returned over 10 times more than the worst. And for children whose families have continued to make regular monthly contributions on top of the initial Government handout, the differential will be far greater.
Although it's possible to invest your child's CTF money in all manner of different investments, around 74 per cent of parents opt for so-called " stakeholder" plans, which are forced to steer clear of high-risk asset classes, keep charges low, and reduce the risk in the portfolio over the five years leading up to the child's 18th birthday. Most of these are tracker funds that mirror an index such as the FTSE 100 or FTSE All-Share, although there are also a smattering of actively managed equity funds, in which a professional manager will select the stocks.
Nevertheless, despite the tighter rules governing stakeholder products, the difference in performance can still be significant. For example, the worst performing stakeholder fund since CTFs were officially launched in April 2005 is Scottish Widows Balanced Portfolio, which has returned around 15 per cent. In contrast, Liverpool Victoria's Growth fund has returned more than 40 per cent over the same period.
Although any child born after 1 September 2002 will have received a CTF voucher – £250 in most cases, but £500 for children born into families on low incomes – the first vouchers were not actually issued until April 2005, when the scheme officially got under way. Those born between September 2002 and April 2005 were given a little extra cash to make up for the delay, but were still not able to invest their money until April 2005.
If you are one of the thousands of parents to have not bothered to invest your child's CTF voucher within a year of receiving it, it will have automatically been invested in a stakeholder account at random. So if your child is five today, the £277 that he would have been awarded in April 2005 will now be worth less than £320 if it was invested in the Scottish Widows Fund, compared to almost £390 in the Liverpool Vic fund. Imagine what this differential might be after 18 years.
The good news is that it's not too late to make a change for the better: one of the rules governing stakeholder accounts is that parents retain the right to switch in and out of products for free. The bad news is that most financial advisers will be reluctant to give you advice on what to do, as the sums involved are too small – so it's important to do a bit of homework.
Before deciding where to invest, the first decision you need to make is how much risk you are willing to take. If you are very risk averse, you do have the option to put your child's CTF voucher into a cash savings account, where it will earn somewhere in the region of 6 per cent a year.
However, given the length of time that your child's money is going to be invested, the stock market is not nearly as risky an option as you may think. Over any given 18-year period in the last 108 years, shares have only once been outperformed by cash – and that was more than 50 years ago, according to the Barclays equity gilt study. "Over this kind of time period, you'd be daft to invest in a savings account," says Guy Knight of The Share Centre. "Most of your returns will end up being eroded by inflation."
The best savings accounts at the moment are offered by building societies such as Britannia and Skipton, and pay around 7 per cent. But interest rates look to be nearing their peak, and these savings account rates are likely to fall over the next few years.
If you're willing to invest in stocks and shares, your next task is to decide whether to plump for a tracker fund or an actively managed fund. Miles Bingham of Family Investments says that picking a good fund manager to run your money will always produce better returns in the long-run. As well as getting the benefit of their stock-picking ability, fund managers also have the flexibility to time their purchases. "Tracker funds are fully invested all the time," he says.
Family's CTF is managed by New Star Asset Management, one of only a handful of actively managed stakeholder CTFs. Although its performance has been slightly worse than the tracker funds since launch, Bingham says he believes that it will produce superior returns over the full 18 years.
One of the main benefits of stakeholder funds is that their charges are low. The choice, however, is relatively limited. If you're looking for more exotic investments, there are a handful of packaged non-stakeholder CTFs that are also relatively cheap – the range of Exchange Traded Funds (ETFs) offered by Redmayne Bentley, for example – but again, there is not much choice.
If you want to be able to invest your child's money in a greater range of assets – including individual shares, or specialist funds – you'll need to opt for a self-select CTF. However, the charges in these can be much higher and do not always merit the cost.
Justin Modray of Best-Invest says that parents making additional contributions into their child's savings may want to think twice about using a CTF. Although all returns and income in a CTF are tax-free – and up to £1,200 a year can be invested in additional savings in the funds – the charges tend to be much higher than investing in a regular children's savings plan. "The cheapest tracker you can buy in a CTF is run by F&C, and still charges 1.2 per cent," Modray says. "Outside of a CTF, Fidelity offers a tracker costing just 0.3 per cent a year."
Although the best performing CTFs so far have been exotic investments such as Redmayne Bentley's China ETF, Modray warns parents not to get carried away when choosing where to invest their child's money.
"The top performers so far are all higher-risk investments which have thrived during the buoyant markets we've experienced since CTFs were introduced," he says. "However, parents should not be seduced into taking more risk than is appropriate. Recent weeks have been a timely reminder that what goes up can also fall quite rapidly, and investing in areas such as China and smaller companies requires a steady nerve. For many parents, a good stakeholder CTF would be a more sensible route. Returns are likely to be less erratic, and the investment will be phased away from stock markets and into safer areas between ages 13-18, reducing the likelihood of plunging stock markets hitting the fund as your child approaches age 18."
Although the small sums of money involved with CTFs mean that it's hard to get financial advice, The Share Centre does offer a free telephone-based advice service for its customers. There are also a range of tools and tips to help parents at its website (www.share.com).
For more basic information about CTFs, visit the Government's website: www.childtrustfund.gov.uk
"It's all about education"
Duncan and Melanie Tanner, from Cuckfield in Sussex, had their first daughter, Iona, in May.
When Iona's £250 Child Trust Fund voucher arrived a few weeks later, Duncan began doing some research to decide where to invest the money.
"I spoke to some friends and lots of them had invested their Child Trust Funds in stocks and shares, so I did some research on the internet to find the best account."
Duncan was impressed by Family Investments, whose CTF is managed by New Star Asset Management. "Family looked like they had a good track-record in terms of performance, and they made it very easy to make extra payments to the fund."
The Tanners are paying an extra £20 a month into Iona's fund, and are hoping that their friends and family may also contribute in the future.
Duncan hopes that the fund will build into a healthy nest egg which Iona can use to fund herself through university. "Like most people, we think it's all about education, helping our daughter to afford the fees to get to university when she's older," he says.
Child Trust Funds: the facts
What are Child Trust Funds?
Since 1 September 2002, all children have been given £250 (or £500 for those born into families with low incomes) by the Government. This money can be invested by their parents in a savings account or in the stock market, in accounts that are known as Child Trust Funds, where all growth and income are tax-free. The Government makes an additional payment of £250 (or £500 for qualifying families) into the account when the child reaches the age of seven. The child can only gain access to the money once they reach 18.
How do I know if my child qualifies for the larger payment?
Families with a total household income of £14,495 or less will receive an extra £250 for every child, both at birth, and when they reach the age of seven.
Can I make additional contributions to my child's CTF?
Yes – up to an additional £1,200 can be invested in the accounts each year.
What is a "stakeholder" CTF?
Stakeholder CTFs are accounts that are governed by slightly stricter regulations. They cannot invest in high-risk asset classes, their charges must be below 1.5 per cent a year, and they must move children's money into less risky investments over the five years leading up to their 18th birthday. The majority of stakeholder accounts are index tracker funds, which mirror the performance of an individual index of stocks.
What are the other investment options?
Those who are looking for less risky options can put their child's money into a cash savings account. For higher-risk investors, self-select CTFs allow parents to invest their child's money in a much wider range of assets.
Can I switch between funds later on?
Yes. However, additional charges may be incurred for those who are switching in and out of non-stakeholder accounts.
What happens if I don't use my child's CTF voucher?
A year after your child is born, their voucher will be randomly allocated to a stakeholder account.