Most parents and grandparents will appreciate the importance of watching over their children as they grow.

But the same is true of their children’s savings. For while it may be tempting to think that simply choosing a cash account for your child’s Child Trust Fund (CTF) voucher or setting up a regular savings scheme into an investment fund is sufficient, active management of your child’s investments will almost certainly result in better returns in the long run.

The importance of equities

A key question is where to invest. The first instinct of many parents will be to opt for the security of cash. But, as the table on page 18 demonstrates, this is rarely a good way to achieve a competitive return. And the fact that a children’s savings plan will typically have a timescale of 20 years or so means that a core element can be invested in the stock market.

As Graham Spooner, an investment adviser at The Share Centre, points out, ‘Equities are most suitable when planning for a child’s future. You don’t have to worry too much about short-term volatility because you have plenty of time to overcome any setbacks or market corrections. This offers parents the flexibility to play around with their portfolios and adopt different strategies.

‘As with any investment based on stock market growth, past performance is no guarantee of future performance. However, over most 18-year periods, stock market investment has performed better than cash investments.’

Jason Britton, fund manager at T Bailey, points out that ‘The FTSE 100 and FTSE All-Share have provided positive returns in 11 of the last 15 complete tax years, averaging total returns of 11.1 per cent and 11.4 per cent respectively. That is much better than a savings account in a building society. In fact, if you had invested £50 a month in a typical savings account over the past 15 years, assuming LIBOR rates, it would now be worth £12,500. Invested in a fund that matched the FTSE All Share Index over that period it would be worth £18,500, having grown almost three times as much.’

Keeping active

Investor psychology plays an important part. Andrew Bell of stockbroker Rensburg Sheppards points out that ‘You could lock £500 away for your child at birth and not worry about it in the way you would if you were investing £5,000 or £10,000 for yourself. That is the big advantage of having a long-term time horizon: it deals with your impatience with short-term returns.’

He adds, ‘When you get market scares like we have seen recently, there is a great temptation to sell out of everything. As long as you are invested in good businesses, you are less likely to be affected by short-term scares, whereas if you are constantly watching the market, they are the points when you would be most tempted to sell.’

Indeed, it may be wise to go against your natural instincts when setting up a savings plan on behalf of your children. James Budden, marketing director at Witan Investment Trust, argues that ‘It really depends on your attitude to risk, your skill and how much attention you are going to pay to your investment. In terms of saving on behalf of children, there is actually an argument for starting off with something high risk, as you have time to allow for the effects of the volatility.

‘So, something like emerging markets might be an attractive option if you are starting an investment you know will have 20 years or more to run, but with shorter time horizons you might want to be more circumspect.’

Graham Spooner agrees: ‘When starting out, you may wish to be a little more adventurous by choosing growth-orientated or higher-risk stocks. Once the portfolio is more established, you may want to look at balancing the assets. It is hard for parents to do this at the start for fear of spreading their investments too thinly. Certainly, a year or two before the CTF matures parents might want to start thinking about moving into lower-risk investments.’

Jason Britton adds, ‘If you are saving for a specific period – from birth to age 18 for example – then you don’t want to lose your gains through unfortunate timing of your exit. You should probably consider treating these investments like you would a pension and so, towards the end of the period, start moving savings across into cash or lower-risk funds.

‘Although past performance is no guide to the future, over the past 18 years a basic CTF investment would have grown to £2,500, based on the average annual return of 10.75 per cent achieved by UK equities over the period. That is quite a sizeable difference. I think it’s a no-brainer to put your child’s CTF into equities.’

Long-term benefits

Mark Noble, head of retail sales and marketing at SVM, argues that ‘The friend of risk investment is time. The longer you go on for, the more risk you should be able to take. If you look at five-year periods, you may get some when bonds outperform equities, but very rarely does that happen if you look at rolling ten-year periods.’

Andrew Bell argues that ‘Just as with any group of investors, a lot will depend on what the individuals want out of the investment: for example whether income or growth is a priority. If the parents are gifting money, they will be taxed more on it if it is generating income.

‘What also matters is whether you want to invest and forget about it or actively manage your savings. If you are just putting money aside then you might as well put it into Foreign & Colonial and forget about it, but more active management requires a strategy.’

Indeed, it is not surprising that generalist investment trusts, with portfolios invested across a wide range of markets and assets, are often cited as an ideal home for this type of long-term saving, particularly for those parents without the time or the inclination to actively management the investments.

Witan’s James Budden explains that ‘Generalist funds, like ours, do all of that for you, as we have the same strategic aims as the long-term investor. If you just want to buy something and run with it, then the generalist approach is the way to do it.’

Mark Noble says, ‘We would argue that our SVM Global fund is the ideal solution for this type of investing. Our style is unconstrained investment in global markets. We concentrate on finding high-growth assets that are going to outperform, but balance that out with a range of defensive assets.

‘So, over a 15-year period, the fund would have had a higher or lower weighting to different types of assets, depending on how we think the market is going to go. From time to time we will take positions in more exotic areas, but will still limit the overall risk profile.’

Off-the-peg solutions

Another key question is whether to invest via a packaged product specifically designed as a children’s savings vehicle or to make your own arrangements. James Budden notes that ‘A lot of financial advisers take a jaundiced view of children’s savings products. They see them as simply a marketing gimmick, but that can be a little unfair. With something like our Jump scheme, which is invested in our main investment trust, it is the core of what it is invested in that is the crucial thing. Then there is the question of costs. Charges on racier funds tend to be higher and that will become an issue over time.’

Rensburg Sheppards’ Andrew Bell emphasises the point that it is important to take the costs of your investments into account: ‘You would also probably want to avoid some of the more expensive ways of getting absolute return. Again, there is a very big difference in returns between an investment that has an annual management charge of three or four per cent and one with 0.5 per cent.’

Looking ahead

It is also important to think about what is likely to happen over the next 20 years, which is a long time in investment terms. As the table below shows, relative performance of different types of investment can fluctuate dramatically over periods of five years, let alone two decades.

Andrew Bell suggests that ‘If you are looking for returns over a period of 20 years or so, I would have thought that you will be more in growth than value and would be more highly weighted in those areas of the world that you think will have grown in economic importance in 20 years’ time.’

He adds, ‘You will tend to be more in areas that will grow the value of your capital, so you will be in emerging markets rather than developed markets, as five to six per cent a year will give you a significantly higher return over 20 years than two to three per cent.’

And Mark Noble reminds us that ‘Investors should be looking for long-term assets. It is less sensible to invest in cash over the long periods of time for which children’s savings are invested.

It is not as if you have a specific liability to match, either. You are simply looking to build up the biggest lump sum possible.’