Holly Thomas: Ignoring the stock market could cost your child thousands of pounds
Younger people today face a lifetime of financial challenges such as funding eye-watering university fees and saving a deposit for a property - not to mention the less generous pension schemes available today compared to those enjoyed by their parents and grandparents.
The average cost of university debt is now around £50,000, while the average property price in London is now almost £480,000 – making a 10% deposit close to £50,000. It’s not surprising, therefore, that parents (and grandparents) are increasingly putting money aside for their children (and grandchildren).
There are numerous ways (and accounts) in which you can save for your children. Banks and building societies heavily market children’s savings accounts which often come with much better rates of interest than those for grown-ups.
But saving into a bog standard savings account each month might not always be entirely positive.
While it is probably the safest place for your money (as up to £85,000 in a bank or building society could be covered by the financial services compensation scheme, unlike stocks and shares investments), leaving your money in these accounts exposes your savings to the corrosive effects of inflation. Inflation erodes the value of your money over time, especially when interest rates are low, as they are today.
An alternative is to invest that money in the stock market. Although this approach is far from risk-free, stocks and shares have historically outperformed money in savings accounts over the long term. Past performance is not a guide to future performance, of course, but I’ll give you a case in point.
As an example, £10,000 invested in the FTSE All Share index 18 years ago would now be worth £26,170. However, £10,000 deposited in the average UK savings account over the same period would be worth just £13,120. That’s a difference of £13,050.
Taking into account the rate of inflation, known as the consumer price index (CPI), over the past 18 years, the £10,000 would have needed to reach at least £14,610 just to keep up with inflation. So the return on cash savings means there would have been a loss, with the real value of the savings severely eroded.
As these figures demonstrate, ignoring stock market-based investments could have a serious impact on the overall value of savings.
I believe, it is also important to start saving as early as possible. Parents who invest for their child from birth could benefit from a longer time period for the savings pot to grow, therefore potentially reducing the amount they need to invest each year. Regular investing is also an important habit to develop as this can help to smooth out the ups and downs of the stock market.
It is also vital that you choose the right type of investment account. There is a junior version of the tax-free Individual Savings Account (ISA), into which you can save a set amount in each tax year. This year it’s £4,368 and there is no tax to pay on capital gains. A Junior Isa, like the adult version, can hold cash as well as a variety of investments, including individual stocks and funds. Remember tax advantages do depend on individual circumstances an can change in the future.
The money in a junior ISA is also locked away until your child reaches the age of 18, at which point the account is signed over to them and they can have control of the money held within it.
Some children aged between around 7-16 might may also have a Child Trust Fund (CTF) account. CTFs were opened automatically by the government and although they've been replaced by Junior ISAs, there are around one million dormant accounts in existence. information on CTFs can be found here.
Forward-thinking parents might also want to consider starting a pension for their new-born. Although this might sound a little extreme, this savings route offers significant tax breaks. It is possible to invest up to £3,600 per year into a self-invested personal pension (SIPP) from the day your child is born. And because of the current tax benefits, you would only need to invest £2,880 (or £240 per month) to achieve the maximum amount each year, with the balance automatically reclaimed from the government. Again, be mindful that the current tax regime may change in the future.