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The decision about whether to set money aside on your child’s behalf is a deeply personal one. Famous investor Warren Buffett, for instance, is only leaving a fraction of his vast fortune to his children – believing they should build wealth themselves, and giving 99% to charity instead. Yet others think that their generation “had it easier” than those growing up today, and they deserve a “leg up” financially. Assuming you want to set aside even just a small amount for your child to use one day – perhaps for a house deposit, wedding or university – what is the best way to do it?
Below, our financial planning team at Cedar House shows why parents should not simply default to cash. Rather, investing on your child’s behalf – using an appropriate strategy in light of your risk appetite, time horizon and personal goals – is typically a better approach. We hope you find this content useful. If you’d like to find out more or discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
Why cash is not king
Today in 2021, the interest you can generate on savings accounts is very poor (partly due to the historically-low base rate, at 0.10%). You are lucky to find an easy-access savings account near to 0.6% and fixed accounts have been spotted up to 1.7%. When you factor inflation in, which is set at a target 2% by the Bank of England (BoE), this typically results in a real-terms loss if you leave cash in a regular account for your child even for a few years (until they turn 18).
Junior ISAS (Individual Savings Accounts) can do a bit better. One account lets your child earn 2.5% per year on savings over £2,500. However, this is still only a 0.5% real return over the BoE target rate of inflation. With an investment account, however, it may be possible to earn 4%, 6%, 10% or even more per year (depending on your strategy and also performance).
Investing on a child’s behalf
Many parents are intimidated by the idea of investing – thinking it is only for the ultra-wealth, or that it involves becoming a part-time day trader or stock picker. Yet this is not the case. With the rise of digital technologies, investing has opened up much more to “ordinary people”. Today, it is possible to open an online investment account in minutes, pick a set of investments and begin contributing to it (for you and/or your child).
This ease of access is great news, but it often still fails to solve the common question: “How do I invest on my child’s behalf?” After all, whilst investing offers the chance of higher returns, it also carries more risk (e.g. the stock market could fall, leading to a loss if you sell your investments). This is where a financial adviser can add real value.
A professional can bring their qualifications, skills and experience to the table when helping you decide on the best investment strategy for you and your child. A big factor here is your appetite for risk – i.e. how much volatility can you stomach? If you do not mind the idea of your child’s investments going up and down over time – but ultimately rising overall by the time he/she takes the capital at age 18 – then focusing your portfolio (set of investments) on stocks and shares (equities) may be appropriate. If, however, the thought of this makes your stomach turn, then a more “cautious” or “defence” strategy may be better. Bonds, for instance, can still offer a better return compared to cash in a savings account, but do not fluctuate in value as much compared to equities. A bond acts a bit like a bank loan; except you are the lender receiving repayments with interest, and the borrower is either a company or government.
Your time horizon also matters, however. If you have just had a baby and want to start investing on their behalf, then you potentially have nearly two decades for the capital to grow. This allows you to be more aggressive in your strategy (if this feels comfortable), since short-term losses made along the way have more time to recover. However, if your child is in their teens and you only have a handful of years to invest, then you may need to be more cautious. If a stock market crash occurs, you may not have time for the portfolio to recover – or, your son/daughter might need to wait longer before they start accessing the capital.
Regardless of the strategy you take, it is also crucial to invest in a cost-efficient and tax-efficient manner. A financial adviser can help you identify funds and other investment opportunities that offer strong fundamentals and performance prospects, without compromising on quality. To keep taxes low, moreover, a popular option to consider is the Junior ISA. In 2021-22, this lets you put up to £9,000 into your child’s account on their behalf. Any interest, capital gains and dividends generated within it will be tax-free. You (the parent) would manage the account until they turn 18, at which point they can access the account and do with it as they please.
Conclusion
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk