The advantages of saving for children in a closed-ended fund

What’s the best way to save on behalf of children? Well, think in terms of what you’re hoping to achieve. First, you’re aiming to turn what may be relatively modest savings into sizeable sums one day in the future (think university tuition fees, say, or the deposit on a first property). Second, you’re likely to be saving over an extended period: if you’re starting when the children are still small, it may be 15 to 20 years before they access the money.

Those considerations point you in one direction for your saving. Over the long term, at least in the past, the stock market has outperformed all other asset classes. Stock market investors may have to put up with short-term volatility, but the pay-off for accepting this risk is the potential for better long-term returns. The latest figures from the Barclays Equity Gilt study, the most definitive analysis of long-term asset class performance, show that UK equities have produced an annual return averaging 4.1 per cent a year above inflation over the past 20 years.

The next question, then, is how to get exposure to the stock market on behalf of children. For most people, a collective fund is the best option. You’ll be able to make regular contributions to the fund while leaving a professional investment manager to make the day-to-day investment decisions.

For the investment company sector, the children’s savings market has long been an important focus. Many investment companies have set up savings schemes specifically aimed at parents, grandparents or other relatives and friends saving on behalf of children. These schemes allow you to save as little as £25 a month.

But while they offer convenience, will investment companies deliver the best returns for your children?

No-one can predict the future, but in the past at least, investment companies have tended to outperform open-ended funds, their chief rivals, over the longer term. For example, research published earlier this year by the analyst Canaccord Genuity shows that, on average, investment companies outperformed their comparable open-ended sectors in 11 out of 15 cases over the 10 years to the end of last year.

That may not be repeated in the future. One traditional advantage of investment companies – they have tended to have lower fees – has been eroded over the past couple of years, with open-ended funds able to offer cheaper charges now they are no longer able to pay commissions to financial advisers. However, investment companies retain other advantages – their structure leaves the manager free to concentrate on managing the fund’s assets, for example, and they can take on borrowing to boost returns during periods when markets are rising.

For these reasons, investment companies are likely to continue to be very popular with people saving for children’s futures. A survey conducted earlier this year by Morningstar, the funds analyst, found that 46 per cent of its users thought investment companies were likely to produce the best long-term returns, against 22 per cent for open-ended funds.

Whichever option you go for, think about how you’ll hold your investments. Children under the age of 18 cannot legally own investments in their name, so you’ll have to make a choice.

One option is to set up a “designated” account in your own name but with the child’s initials included, to show whom the money is for. You remain in control and can decide when to hand over the investment – but you’ll be taxed on any gains. Alternatively, you can set up a “bare trust” with the child as the beneficiary and you as trustee – this way, you can use the child’s own annual allowance to shelter any gains from tax, but the money has to be handed over to the child when he or she reaches 18. Most investment company savings schemes can provide the paperwork for both of these options.