Kate Baker, head of savings and investments at Child Trust Fund provider Family Investments, suggests means by which parents and grandparents can take advantage of long-term trends to make the most of their Child Trust Fund voucher.

There is an increasing realisation that providing children with a financial asset can give them a real head start when they reach adulthood.

The Child Trust Fund (CTF) is the most common vehicle for children’s savings due to the money invested in it from the government and its tax-efficient nature. In fact, there is currently upwards of £2 billion of funds under management in CTF schemes across the UK, with more than £22 million being added to them on a monthly basis. It is clear the scheme has encouraged many that have not previously saved for their children to start doing so.

Parents do have choice in how they invest their child’s CTF, and the decision they make can have a big impact on the future value of the asset when their child reaches 18. Quite understandably, choosing how to invest their CTF may not be top of new parents’ list of priorities when there are so many other things to focus on in a child’s first year. However, there are a few simple points that all parents should consider when making this decision, which should make the whole process much easier for all.

Risk assessment
Parents may be less willing to take risks with their children’s money than their own but they also want to provide them with as large a financial asset as possible. In the case of CTFs, the fixed maturity age of 18 years gives parents the flexibility to choose a strategy that prioritises long-term growth and mitigates risk.

There are a range of CTF options to cater for different types of investor, ranging from the risk-averse to the financially experienced. The main choice lies between cash, equity and stakeholder CTFs, with additional options for ethical investing.

The latest figures from HM Revenue & Customs show that 68 per cent of parents choose a stakeholder, 9 per cent choose a shares-based account and 23 per cent choose a cash account.

The default investment
The option available from Family Investments – and the one that we believe the government should promote as default (while keeping the other options that currently exist) – is the stakeholder CTF.

The stakeholder is designed so that the fund benefits from stock market growth in the early years before a series of ‘life-styling’ rules kick in, reducing exposure to the stock market and protecting the fund from risk in the later years. It is parents’ desire to maximise returns but reduce risk as the fund maturity date approaches that has made the stakeholder CTFs popular. Stakeholder products tend to be trackers and so, rather than trying to beat the stock market by predicting rises and falls, they track market trends.

When looking over the long term, research shows that investment returns tend to be higher if they have some exposure to the stock market. Parents should bear in mind that the investment timescale of 18 years means that cash outperforming equities in a CTF is very unlikely. This is backed up by the Barclays Capital Equity Gilt Study 2009, which found that when looking at an 18-year time window, in 99 per cent of cases, shares produced a greater return than cash investments. But of course, parents should remember that stock markets can go down as well as up and that there is the chance, as with any stock market investment, that the child could get back less than was paid in.

In this respect, the stakeholder offers the best balance. It has the advantages of shares-based products in terms of potential stock market growth, and then life-styling offers protection for the fund in the child’s teenage years, as the fund nears maturity, by investing in more stable assets such as cash. This makes the stakeholder a suitable option for many parents.

In safe hands
CTFs based in cash are for the most cautious of parents as the investment is free from exposure to risk associated with the stock market. Interest on the existing balance is guaranteed, but overall returns might be quite small when compared with some other CTF options. Parents are advised to shop around for the best interest rates but a good deal can be hard to find in the current climate, with the base rate set at a record low by the Bank of England, which has dragged down interest rates for savings accounts.

Parents should also try to review interest rates regularly to ensure that they are with the best provider. Over the term of the investment, the effect of inflation can erode the final amount that a child will receive, and although this applies to all CTF accounts, often the cash accounts offer the smallest eventual return, causing the effect of inflation to be more noticeable.

Making the most of it
Those parents willing to take more risk to maximise returns may consider equity-based accounts (the non-stakeholder variety). They provide a wide variety of funds to choose from and the potential for far greater gains than is possible from the average interest rate on a cash-based investment, although stock market fluctuations may also negatively impact the value of the fund.

Worth considering at the moment is the fact that equities have been staging a strong recovery this year, with the FTSE100 rising by almost 50 per cent since five-year lows in the spring.

This means that there is a good opportunity for growth in equities, which is even more compelling with interest rates on cash accounts being so low at the moment.

A potential strategy is to switch equity-based investments into cash and other less volatile assets as the fund develops to protect gains made up to that point. The volatility of the stock market means that parents will need to keep a close eye on their investment to make sure it is performing well. If they are unable to do this because of practical constraints (of which there may be many when you are looking after a family), or they find the risk factor causing sleepless nights, it is probably best for investors to choose an alternative option.

Ethical investing
An increasingly important consideration for parents investing their CTF is the ethical nature of the investment. This has made ethically focused CTFs very popular with parents, as is shown by the fact that approximately half of Family Investments’ CTF customers choose the Ethical Stakeholder CTF option. Ethical funds vary but in general they tend to avoid investing in those companies that profit from such industries as tobacco and arms, or that have a poor environmental record.

There are a variety of reasonsfor the popularity of ethical funds but it does seem that parents with a long-term investment such as a CTF may be thinking about protecting the world for future generations. They may also believe that it is more appropriate that what will eventually be their children’s money is directed positively and towards socially responsible companies.

A comforting reminder
Parents dealing with a growing family may not feel in a position to give a lot of thought to an investment strategy, but it sounds more complicated than it is. The fact that the CTF is invested over the long term makes the decision simpler, and a brief analysis of their own perspective should help guide parents’ decisions.

The 18-year term of a CTF relieves pressure as it allows parents to choose a strategy and re-evaluate at regular, convenient intervals without it demanding constant attention. Parents should gain comfort from the fact that they are free to transfer their CTF at any time, between provider or type of account, so they should not be worried about being locked in after making a decision. Upon receipt of free funds from the government, the only poor strategy would be to not give it any thought at all.

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