Investing for children

This is one of the main reasons that new parents come to see a financial advisor, that they would like to set up an investment for their new child. An investment for a child is usually a great idea but I would like to add one important point before I start.

Making yourself financially successful first is the most important thing. Putting money aside for your children’s futures is a great thing but not if it is at the expense of you meeting some of your other financial goals. Making yourself financially safe and secure will only benefit your whole family over the long term. That been said, if you have put steps in place and you are financially secure and want to start an investment for your children, here’s what you should be thinking about.

The type of investment

Choosing the right investment is always important as it can be the difference between a successful outcome or not. When we’re looking at investing for children, we are usually looking at a long term horizon. When we are investing for the long term we can afford to take on some risk and volatility and this should be something that you’re thinking about when choosing the right investment, you want to choose something that has the potential for growth.

With us currently experiencing record low interest rates, we can no longer keep putting money away in the bank and expect to see big returns in the future. Depending on the amount of money your starting with, a diversified index fund can be a good way to get diversification at a small cost. I find these can usually be good for people just starting out with lower balances.

If you are planning on putting a bit more away then you could potentially look at building your own individual share portfolio, however you need to make sure that this is well diversified so that you don’t leave yourself open to any unnecessary risk. Some people also look towards managed funds as way of getting someone else to manage the investment for them whilst still having an active approach towards investing.

The options for investing for children is pretty much the same as if you were to set up an investment for yourself, it’s just that the goal is to provide funds for your children for the future, so your investment options can be almost limitless. It doesn’t have to be complex, just make sure that the fee’s are competitive if you are going into an index or managed fund, that it’s well diversified and that it is in line with your risk profile. That last point is really important, there’s no point investing in something super high growth if you’re a conservative investor, you probably won’t sleep well at night if that’s the case!

The structure

As with any investment, this is crucial and can make a huge impact in the total return of the investment. The structure means how the asset or investment is owned. When your looking at what structure the investment should be held in, it’s important to look at a couple of things. Your current tax position, what you want the investment to achieve and the time frame for that investment.

There are many different structures that can be looked at for children. I’m going to run through a few and hopefully give you some pro’s and con’s of each to help you towards making a decision. The first one that most people look at is investing in your personal name. This is usually the simplest of options but you need to take into account the tax outcome, keeping in mind that hopefully with this investment we are creating a sizeable capital gain at the end. This structure can work well if you have one spouse who may not be working or working part time and therefore on a lower marginal tax rate, however if both spouses are high income earners then this may not be the best option out there as a lot of the income and gains can be eaten up by tax.

A very popular option for investing for children are investment bonds. Investment bonds are taxed internally at the company tax rate and if held for over ten years there is no capital gains tax payable. This can mean that they become a very attractive option for higher income earning parents. There are some rules around contributions where each year you are only allowed to contribute 125% of what you contributed the previous year or else that ten year period starts again but these are often small prices to pay for the potential tax benefits that come with investing within this structure.

The strategy

The strategy when investing for children doesn’t have to be far removed from what you should be doing with your own investment strategy and that is contributing to it on an ongoing basis over time. By putting funds in on a regular basis you will give the investment the best chance to be successful as you are buying in at different points in the market. Most product providers will allow direct debits so a lot of the time you don’t have to think about it, the money will come from your bank account and get invested, I really like this as it removes another thinking point as to when you are going to deposit and means that you are more likely to follow the strategy and therefore more chance of success.

As I said at the start, the most important thing you can do to provide for your children is to be financially successful yourself. That been said, starting an investment that is separate from your own wealth creation to cover things such as education expenses, first car or even first home deposits can usually be a good idea. Like any form of investment you need to be clear on the goals for those funds and then decide on the best way to achieve those goals.