Investing for Children
Unlike saving, investing usually means taking some risk and potentially tying up money for 5-10 years or more. The reason for taking risks is to try and get a better return on the money compared to a savings account.
If you're planning to put money aside for your child from their early years until they turn 18, then you should at least consider investing and decide whether it's right for you and your child.
Investment returns
Savings have just one source of return, the interest received from your bank or building society.
Investments usually have two sources of return. The change in value ('capital value') of the investment itself, and any income paid to the owner.
Mr X buys a holiday home for £100,000 and rents it out for £250 per week. A year later the property is valued at £90,000 and he managed to rent it out for 20 weeks.
His investment return over the year is therefore a capital loss of £10,000 (£100,000 - £90,000) and income of £5,000 (20 x £250), i.e. a £5,000 loss overall.
The most common investments for children invest in the stock market ('equity investments'). This means buying shares in companies in the hope those companies prosper. When investing in shares your capital return comes from changes in share prices,
while income comes from any profits that companies pay back to shareholders each year, known as 'dividends'.
When making an investment, always try to understand where the returns might come from. It can help you better understand the risks involved.
The options
For a more thorough guide to investing please read the Candid Money guide to investing here.
While there is, in theory, an almost limitless number of ways to invest for your child (e.g. stock markets, art, lottery tickets... etc.), in practice there are five common options:
Junior ISAs / CTFsSharesUnit TrustsInvestment TrustsFriendly Society Bonds
You can invest up to £9,000 a year into a Junior ISA for your child. Both savings and investment options are available.
If your child instead has a Child Trust Fund (CTF) then this can be topped up by up to £9,000 a year.
In both cases, children can't get their hands on the money until they're 18, gains are tax-free and there's no further tax on dividends.
Buying shares in an individual company can be risky. If the company struggles you could lose a lot, or even all of your child's investment. However, get it right and the rewards can be high.
Ideally you should try and spread money across a few shares, which should reduce risk. It's also wise to have a good understanding of any companies you buy, so spend some time researching their business and prospects.
Shares are best bought and sold via an online stockbroker, who'll charge around £10 per trade. This means it's not really cost effective to trade shares unless you're investing a few hundred pounds or more.
Find out more by reading the Candid Money guide to shares here.
Unit trusts are funds that invest in a basket of shares (or other investments such as corporate bonds, commodities or property), in the hope of reducing risk. If one company crashes it shouldn't have a significant impact on the fund.
Some unit trust providers offer funds for children. Ignore the marketing, there's nothing special about these funds, in fact they're quite often mediocre funds wrapped up in some pretty packaging.
Some unit trusts, called trackers, try to mirror general stock market movements by tracking a particular stock market index, while others are run by fund managers who actively try to beat a particular index.
In practice there are some very good fund managers who are mostly successful, and many not so good managers who fail to beat their index more often than not. Sorting the wheat from the chaff is essential if you choose an actively managed fund.
You'll also have a big choice of where to invests - large companies, small companies, UK or overseas are all decisions you'll need to make.
If this sounds too daunting there are also unit trusts that invest in a range of other unit trusts, called funds of funds. These spread the investment very widely but can be expensive as you'll effectively pay two sets of annual charges (the fund itself and underlying funds), amounting to 2% or more a year.
Tracker funds usually have no initial charge and annual charges below 1% while actively managed unit trusts may have initial charges of around 3-5% and annual charges of 1.5% or more, although buying through a discount broker can reduce these.
Minimum investment is usually £500 lump sum or £20 - £50 monthly.
Find out more by reading the Candid Money guide to unit trusts here.
Investment trusts are also funds that invest in a basket of shares, but unlike unit trusts they are themselves investment companies listed on the stock market.
This can add more risk for two reasons. Firstly, an investment trust's share price may not fairly reflect the value of the investments it holds and secondly it can borrow
money to increase its exposure to investments.
Don't worry if this sounds a bit complicated, just appreciate that it can make investment trusts more risky than a similar unit trust.
On the plus side investment trusts have no initial charges (other than a stockbroker dealing fee e.g. £10 online) and annual charges tend to be 1% or less.
Some investment trusts have special savings schemes for children, allowing a cost effective monthly saving.
Minimum investment is usually £500 lump sum or £20 - £50 monthly.
Find out more by reading the Candid Money guide to investment trusts here.
Friendly (or 'mutual') societies were originally formed by groups of people for the benefit of their own local community (i.e. friends) and were once a very important part
of the UK financial system. While there are still over 50 societies today, the majority are small and operate in a similar way to insurance companies.
The reason they might be of interest to some parents is that friendly society bonds offer tax-free returns, although you can only invest up to £25 a month and must save
for a minimum of ten years.
However, friendly society bonds are basically endowments, charges can be high and performance often not that good. If you stop contributions during the first ten years you
might incur a penalty and/or a tax bill.
Minimum monthly investment is usually £15 and the maximum is £25.
Tax
Because most investments, including those outlined above (except Junior ISAs/CTFs), cannot be held by a child until they're 18 (16 in Scotland), they'll need to be owned meanwhile by
an adult or trust for the child's benefit.
If owned by an adult with the investment 'designated' for the child, the adult is liable for both income and capital gains tax until the investment is eventually held by the child.
If the investment is held in a 'bare trust' for the benefit of the child then the child will be liable for both income and capital gains tax. Note that if the income
(including dividends) exceeds £100 (per parent) a year then the parents will be liable to income tax. This doesn't apply to gifts made by others, e.g. grandparents.
Children have the same annual income tax and capital gains tax allowances as adults, currently £12,570 and £6,000 respectively.
For more details of designated accounts and bare trusts click here.
Kid's Investment Jargon
Here's some of the more common kid's investment jargon you might come across:
| Bare Trust | A simple trust that allows investments to be held for the benefit of a child until they reach 18. Someone else (trustees) takes responsibility until then. |
| Designated Account | An investment that is owned by an adult but intended to pass to a child when they reach 18. |