When saving for your child's future, consider all the investment options

Child trust funds may have succeeded in getting thousands of youngsters into the savings habit, but should parents be investing extra cash in them each year or considering other long-term investments?

There's no doubt that CTFs, which are tax-free investment vehicles introduced just over three years ago for those born on or after 1 September 2002, have revolutionised the way money is put away for children. As well as a £250 Government voucher to invest in either cash-based accounts or stock market linked vehicles – plus another £250 when the child is seven – relatives and friends can top up these pots of cash to the tune of £1,200 every year.

Investing the annual maximum could result in a lump sum of more than £37,000 by the time the child reaches 18-years-old, according to The Children's Mutual, while even putting away £24 a month could provide a nest egg of just under £10,000.

David White, chief executive of The Children's Mutual, says these statistics illustrate how regular saving could help forthcoming generations avoid the financial problems being faced by today's youngsters. "We believe a greater number of maturing funds may help deliver debt-free university education," he says. "It could also facilitate young people getting a foothold on the property ladder."

But is putting all your money in one fund sensible? While they offer attractive tax breaks, it might be worth spreading the money around different products to help insulate it from unforeseen shocks. And there's no shortage of options, according to Geoff Penrice at Bates Investment Services, with high street bank accounts; the National Savings Children's Bonus Bond and even the traditional stock market all worth considering. You can even open an Individual Savings Account (ISA), enjoy the tax benefits, and then hand it over to your offspring at a later date.

As far as investing is concerned, embracing diversification is the long-term approach favoured by Ben Yearsley, investment research manager at Hargreaves Lansdown, who suggests it may provide better long-term returns. "I wouldn't rush to pay any additional money into a CTF and would look instead at a straightforward unit trust," he says.

So what should parents do? Well, the first step for those receiving a £250 Government voucher is to invest it as soon as possible, according to Matthew Carter, Nationwide's savings director. Every day you delay means interest is being lost. A £250 voucher could have received £13.75 interest in a cash account in the first 12 months, he adds, while if the full amount possible was invested then it could mean almost £60 being added.

Sadly, statistics compiled by HM Revenue & Customs reveal that little more than 70 per cent of people are opening accounts. The rest let them expire and wait for the Government to automatically allocate an account on their behalf.

So where can they be invested? Well, there are three possible ways to invest: a cash-based account; a stakeholder account, which is invested in the stock market across a number of companies, subject to Government regulations; and non-stakeholders, which buy shares. So far, those who had invested in equity-based accounts back in April 2005 would have been significantly better off than those in cash-based products up until a year ago, but the stock market volatility means it's no longer quite so clear cut.

A comparison of a selection of cash-based and stakeholder CTFs carried out by Moneyfacts reveals that the average return for both types of account up to the end of August 2008 is around 21 per cent. For example, a £250 voucher invested in the F&C FTSE All-Share Tracker 1, back in April 2005, would now be worth £318.20, representing growth of 27.28 per cent. This, however, includes a fall of 8.48 per cent during the past year. Markets have slumped even further in September. Suzanne Greener of Moneyfacts, says the figures illustrate the inherent volatility of equity funds and stresses they should be seen as long-term investments only. "Those who invested in equities this time last year will already have seen their initial investment reduce. However, over the long-term, equity-based investments have previously outperformed deposits," she says.

After that £250 has been invested then it's up to parents how money should be invested, says Andy Gadd, head of research at Lighthouse Group, and this decision should be based on their objectives and time horizons. "If an investment is being made by a parent at birth for their child's 18th birthday then stock market investments should be considered, as short-term volatility and even market cycles are potentially taken out of the equation," he says. "However, if the savings are for school fees payable within five years then lower risk investments such as bank deposit accounts should be a priority."

Whatever option is chosen, Kevin Mountford, head of banking at comparison site moneysupermarket.com, says regular saving is crucial. "All it takes is a monthly deposit of £50 and your child could have enough cash to finance further education, or to help buy a first home," he says.