Chatting after lunch on Easter Sunday, my brother-in-law asked me to suggest a good place to put some money for his son, my nephew, for the future.
My nephew is four, so this pot of money has about 14 years to grow and be added to until it’s ready to be spent on whatever 18-year-olds in 2033 will need cash for.
“I just want it to build gradually and not fall so we know it’s going to be worth something when he needs it”, my brother-in-law explained. “I’ve had a look and the best thing seems to be some kind of bond.”
The “bond” in question was a 5-year cash savings bond, rather than a corporate or government bond (because the financial industry likes to confuse you if at all possible). The best rate he had been able to find was about 2.7% per annum. I’ve since been to look for the best rates on child cash savings and found that there may be better headline rates available, although these may be time limited with strict rules on maximum contributions and withdrawals.
Over the years I’ve learned to avoid giving financial suggestions to friends and family on the grounds that what they usually want is an inside tip on the next get-rich-quick investment - something I (or anybody else, for that matter) is unable to provide. But this time I felt I might be able to help.
I attempted to explain that, while a perfectly natural instinct, it could be a costly mistake for my brother-in-law to protect his son from the risk of financial markets. Parents spend their whole lives removing any sharp edges from their child’s world but, when it comes to long-term saving, you actually want a few. Volatility and the risk of loss are the price investors pay for returns that have, historically, beaten cash.
Moreover, at four-years-old my nephew was better equipped than perhaps anyone else around the table on Sunday to handle any volatility in the value of his savings. That’s because he doesn’t have to worry about their value for many, many years. The sooner you need invested money, the more you need to pay attention to downside risk. It’s the same reason that people with many years of work ahead of them should not obsess about day-to-day movement in the value of their pension.
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I suggested to my brother in-law that the stock market would be a good place for this money. Over time, as my nephew gets closer to being able to access the money, he could consider shifting it from shares into short-dated bond funds or cash to reduce the risk of sudden losses.
I have previously found that, for those nervous about stock market investing, explaining the benefits of dividends to returns can be a real comfort. Dividends from the FTSE 100, for example, have historically delivered a yield of about 4% to investors, and the yield for 2019 is expected to be higher than that. If reinvested, this adds ballast to investors’ overall return and helps to smooth out ups and down - never forgetting, of course, that both capital values and dividends can fall.
Investing globally is another way to diversify and reduce exposure to any one market. Fidelity Global Dividend is managed by Dan Roberts and looks for companies around the world that pay healthy and reliable dividends. It features on our Select 50 list of favourite funds.
Another option could be the Fidelity Global Quality ETF. This invests passively, so for a lower charge, and aims to track the performance of an index of global companies which pay a high dividend income. It features on our Select ETF list.
Holding these investments inside a Junior ISA means returns can grow without ever attracting tax. There’s a £4,368 annual cap on contributions and the money can only be accessed once the child reaches 18.
More on Junior ISA
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. The value of tax savings and eligibility to invest in an ISA depend on personal circumstances. All tax rules may change in future. Withdrawals from a Junior ISA will not be possible until the child reaches age 18. Select 50 is not a personal recommendation to buy or sell a fund. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.