Start saving early if you want private education

SCHOOL FEES

School fees are often the single largest financial commitment made by parents, knocking the mortgage well into second place.

Despite recession, school fees have continued to rise. Figures from Isis, the Independent Schools Information Service, show that for the six years up to 1991/92 school fees inflation was in double digits. For the 1993/94 academic year it was 2.6 per cent, but it is not expected to hold down at such levels for long.

Paying fees out of income is not possible for many parents. So unless you can persuade grandparents to help, the golden rule is start saving early.

There is no special trick to investing for school fees. A school fees portfolio can look the same as any other investment portfolio, but the aim is different. Investments are timed to produce the required sums, once the children start school.

The form of investment can vary across the risk spectrum, from building society high interest accounts to emerging markets and commodities. Much depends on the investor's attitude to risk. That said, there are investments producing good returns over the longer term that lend themselves to school fees portfolios. Preferred investments include personal equity plans, with-profits endowment policies and zero dividend preference shares.

We asked three firms of advisers for suggestions for funding two children through independent day schools from the age of 11.

As a sobering illustration of the sums of money involved we assumed grandparents have donated a lump sum of £55,000. The children - a boy aged four and girl aged two - are expected to go to King's College, annual fees approximately £6,000, and Wimbledon High School, annual fees approximately £4,500. School fees inflation is expected between 5 per cent and 6 per cent a year.

Whitehead & Partners, independent financial advisers, recommend with- profits endowment plans (see table). Roger Mattocks of Whitehead defends endowments against recent criticism of high front-end commission and falling terminal bonus rates. He points out that the yield on Scottish Widows' 10-year plan at 10. 62 per cent a year is well ahead of comparable low- risk investments in building societies or National Savings.

Endowments also offer security - once annual bonuses are added they are guaranteed - and they come with life cover. The fall in annual yields from around 14 per cent to 10 per cent merely reflect the lower inflation and lower interest rate environment, Mr Mattocks says.

Although endowments are inflexible - early encashment could lead to a loss - they are intended to be long-term savings vehicles. He accepts that equity funds may do better, but not all have. If there is no lump sum and savings are built up from scratch on a monthly basis then Whitehead recommends investing in personal equity plans in conjunction with endowments.

Premier Unit Trust Brokers stresses the long term outperformance of equity markets against other forms of investment and the tax advantages and flexibility of PEPs - which can be used by the parents at any time for any purpose. Because of the volatility of equities Premier will not give projections of how much money will accumulate.

The current strategy is to run growth portfolios 80 per cent in UK funds and 20 per cent in Japan.

UK funds recommended are Newton Income 1995/96 PEP, GT Income 1995/96 PEP, Perpetual High Income, Morgan Grenfell Equity Income, Hill Samuel UK Emerging and Edinburgh Smaller. The recommended Japanese element is Gartmore Japan and Schroder Japan Smaller Companies.

In later years, Premier would PEP further parts of the portfolios assuming PEP rules remain unchanged. Mr Edwards does not advocate monthly savings in PEPs, because it ties the investor to one management group, but instead suggests those without a lump sum accumulate cash elsewhere until a sensible lump sum is reached.

Zero dividend preference shares - one class of share in a split capital investment trust - suit investors who like the comfort of knowing that fees will be covered over a given number of years. Zero prefs have a pre- determined rate of capital growth. They pay no dividends and so are free of income tax and are tax-efficient for those not using their annual capital gains tax allowance. There are 40 zero dividend preference shares in issue with annual yields between 7 per cent and 11 per cent. Split capital investment trusts have a 10-year life.

Michael Thompson, associate director of the stockbrokers Gerrard Vivian Gray, says zeros are particularly useful for school fees plans for older children starting fee-paying school in the next three to four years.

For the four- and two-year-olds whose needs go beyond existing issues, he suggests two alternatives. Either invest for the three years 2002, 2003 and 2004 to produce the required fees and put the balance in Johnson Fry European Utilities Trust to redeploy in new zero issues when they become available. Or use £25,000 to cover the first four years of fees and put £30,000 in gilts, also pending the issue of new zeros.