Saving habit may be best present for Christmas

What should you buy the children this year? How about a pension waiting for them at 65?

Christmas is looming large, and pressure on parents, godparents and friends to stock up with Harry Potter videos, Barbie dolls or Nike track suits is getting stronger. Starting regular savings or investment plans for children will not produce instant gratitude, but will make far more difference to their lives by helping them to finance gap years, university or even the deposit on a house..

In 2005, the Government is launching a ready-made pot into which to pour children's savings, in the form of the £250 Child Trust Fund for every child born after 1 September, 2002. But it is worth starting your children's or grandchildren's nest-egg now.

National Savings, friendly societies, unit trusts and investment trusts all offer regular savings schemes to build up funds for children. Banks and building societies also have plans, though most of them are strictly short term and laden with gimmicks.

National Savings Children's Bonus Bonds are the best known long-term plan for straight savings. People can put up to £1,000 in the present issue of five-year bonds, which pay a fixed, annual 4.4 per cent. The money is tax-free, but few children pay tax, so that is not the advantage it seems. When there is talk of a rise in interest rates, as now, it can look distinctly unexciting

Many children with money in bank and building societies lose because interest comes tax- paid and they are not taxpayers. Parents can get round this by filling in Inland Revenue form R 85, to ensure the interest comes tax-free, at long as they have not provided the money. It has to come from grandparents, or others.

The Halifax offers 4.8 per cent for regular savings on a regular one-year savings bond and Yorkshire building society provides a similar rate in its Treasury Bond account. But generally rates are flat.

The serious money should be invested. Anyone who really wants to think long-term can take out a stakeholder pension from Legal & General and other pension providers. That should provide a decent income the holder is 65. Friendly societies and the National Savings children's bond offer more financial sex appeal, because you do not have to wait as long for the reward.

Friendly societies such as Children's Mutual qualify for tax relief on regular savings plans, which usually take the form of 10-year endowments. Money rolls up in a tax-free fund and there is no tax charge when children collect. The snag is that people cannot save more than £25 a month, or £300 a year. Most plans come with profits and children have an absolute right to the money at 18.

HomeOwners Friendly runs a scheme based on a whole-of-life policy, where the only levy is a 1 per cent annual charge. The plan is unit-linked, and the funds can remain where they are until the beneficiary reaches 21. There are plenty of other investment options, via unit trusts and investment trusts. Some groups highlight saving for children as a marketing tool, for example, Invesco Perpetual's Rupert Bear fund.

Anna Bowes, of the independent financial adviser Chase de Vere, says: "Whatever the hype, the crucial message is that investing money in almost every 10-year period in the 20th century has produced better results than saving it in a deposit account. Regular savings plans avoid the problem of timing, so investors don't risk having to cash in at the wrong moment. What's more, you can you can always top up the funds with lump sums as you want."

Few people investing for 10 or 15 years put stress on income, but it is unwise for parents. They have to pay tax themselves on anything above the first £100 their child gets.

Many people opt for tracker funds, where results mirror what happens to the FTSE index, but many of the top 100 companies it covers are too large for these funds to give a wide spread of risk. Trackers based on the more broadly based all-share index, covering the top 600 companies, offer a better spread. Because they involve less work for fund managers, tracker charges are low, typically from 0.3 to 1 per cent.

Penny O'Nions, of the financial adviser the Onion group, says: "Worldwide growth funds covering a mass of different markets provide the best spread of all. One fund which is regularly in the top quarter over 10 and 15 years is Fidelity Moneybuilder."

Investment trusts are emerging from the cloud created by the massive scandal surrounding split-level trusts, where managers had borrowed heavily to invest in each other's trusts, creating a horribly unstable pyramid. Investment trusts arecompanies which invest in other companies and, unlike unit trusts, can borrow money to do so. Because their own shares are traded, their prices do not just match the value of their underlying investments, but generally fluctuate more widely. Those two points ensure they offer higher risks and rewards than comparable unit trusts.

Two successful broadly based investment trusts are the Witan Jump fund, aimed specifically at children, and New Star Global Opportunities. Scottish Investment Trust, which also has a good record, has just launched Flying Start, its own children's fund.

'When I have picked a fund, I always keep it'

Bill Grant's five grandchildren range from 12 years old to 18 months, and each has a nest-egg. Mr Grant, a retired British Telecom engineer, starts a £25 regular monthly savings plan when a new grandchild appears, and the money will be theirs when they are 18. He hopes they will leave the money where it is, or start their own savings plans.

"I have used investment trusts to build up capital for the past 40 years, and always keep an eye on the sector," says Mr Grant, who lives in Aberdeen. "Fortunately, I had doubts over the split-level funds, so I did not get caught out when things went wrong."

He uses Edinburgh-based trusts and funds, such as Scottish Value and Edinburgh World Wide, and wants as wide a spread of risk as possible. He was once caught in a specialist fund, putting money into India, and has not forgotten. "When I have picked a fund, I always keep it," he says.

"Switching from trust to trust can go wonderfully if it works, and catastrophically wrong if it does not. I want good, stable performance over the long term, and that's what investment trusts have given me."