How to make the most of your child's Junior ISA savings

Monday, July 30, 2018 - 12:27

Inflation is high, meaning the spending power of your money is being eaten away. At the same time, cash interest rates offered on savings are at historic lows. This means that money left in cash will earn very little, or in many cases will lose money in real terms.

This is particularly a problem for money left invested for a long period of time. Worryingly, 61% of money in Junior ISAs, which is invested for the long haul, is left in cash.

Junior ISA money can’t be accessed until a child reaches the age of 18, meaning that money tends to be locked up for a long period of time, so leaving it in cash can be dangerous.

Inflation is 2.4%, and the highest paying cash Junior ISA account currently pays 3.5%. If you contribute the full annual Junior ISA allowance of £4,260, you would earn £149.10 in interest in the first year. However, once the effect of inflation is taken into account you are left with just £46.80 in interest.

This is with the top paying Junior ISA. The best cash Junior ISA rate from a high-street bank pays 3pc. This would give you £127.80 after the first year, on the full £4,260 allowance, or just £25.56 after inflation is accounted for.

For those planning to put the money away for five years or more, they can consider opening a stocks and shares Junior ISA instead, and invest the money. As investment markets rise and fall, it is usually suggested that savers need to be willing to leave money invested in the market for at least five years to ride out these ups and downs.

A general rule of thumb is a return of 5% or 6% after fees for those investing. The actual return depends on how risky the investments you choose are, how long you’re investing for, and how markets perform during that time.

At a 6% return, those putting the full Junior ISA allowance in would get £255.60 in returns after the first year if they contributed the full annual Junior ISA allowance of £4,260, or £153.36 after inflation.

The power of compounding

Compound interest is a saver’s best friend. It was described as the “eighth wonder of the world” by Albert Einstein and can have a dramatic effect on boosting your savings.

Put simply, it means getting returns on your previous returns. It sounds simple enough, but over long periods of time this multiplying effect can supersize your returns.

Let’s look at an example. If you invested one year’s Junior ISA allowance at the start of a child’s life and left it alone for 18 years, not making any more contributions, that £4,260 would turn into £12,160 by the time the child was 18, assuming a 6% return each year.

In the first year you receive £255.60 of interest, which gets added to the initial £4,260 investment. In the second year you then receive 6% interest on that £4,515.60, which equals £271.

This in turn gets added to your existing money, taking your savings pot to £4,786.54 and the next year’s interest amounts to £287. After 10 years the same 6% return on your investment equals £432, and after 18 years that annual interest has risen to £688.

I don’t know where to invest my Junior ISA money

First-time investors can find it daunting to start out, and it can seem like a big leap to move from a cash account to investing your money and, more importantly, choosing where to invest it.

There are some easier options for those not yet au fait with investment markets, and who don’t have time to monitor their investments regularly.

One option is ready-made funds, these so-called “all-in-one” funds aim to spread your money across a range of different areas, including bonds issued by companies and governments and shares in different companies. They also spread the investments across different regions, including the UK and the US, but also newer, emerging countries such as Brazil or China.

Sometimes these funds use cheap, or low-cost, “passive” or tracker funds. These simply mimic the performance of an index, such as the FTSE 100, and deliver similar returns. This means that if the FTSE 100 rises by 10% you can expect the passive fund to deliver a similar return, but equally if the fund falls by 5%, the fund will also fall by a similar amount.

AJ Bell has a range of ready-made funds that use passive investments to create a one-stop shop portfolio for investors. The charges are capped on at 0.5% a year, and the funds’ investments differ based on your tolerance to risk: from Cautious to Adventurous, with each fund allocating different proportions to stock markets.

Another option is “active” funds, where a fund manager buys shares in companies that they think will do better than the average. The aim is to deliver higher returns than the market when it is rising, and to not lose as much as the market when it is falling. These funds cost more each year than the passive funds, which will of course eat into any performance.

More sophisticated investors, who feel more comfortable with how investment markets work, can choose their own funds to put together a portfolio. They can pick between passive or active funds, but will decide how much they put into each area, whether that’s bonds issued by the Government, or stocks in America.

Those wanting a whittled down list of the available funds can use the AJ Bell Favourite Funds list. The list has a spread of funds in different areas, such as UK stock market funds or emerging market funds.

While any investment should be made for the long-term, and investors should avoid switching between different funds too regularly, those taking this approach will need to monitor their investment pot to make sure the funds are still performing as intended and that the funds they’ve selected are still right for them.

Because Junior ISA money cannot be withdrawn until the child reaches the age of 18, this gives a clear time period for investors to base their decisions on. The general rule of thumb is that the longer you are investing for, the more risk you can take.

This means if you are investing over a shorter period you might want to stick to “safer” investments, such as bonds issued by the government and companies, or shares in companies based in developed countries, such as the UK and America.

Those investing for longer periods, over the full 18 years of the Junior ISA for example, could take more risk by investing more money in stocks and shares, or putting more money in emerging markets, such as Brazil, China, Russia and India. AJ Bell has recently launched its Global Growth Fund, which invests in these markets, as well as new areas of technology, such as artificial intelligence and robotics. Charges on the fund are capped at 0.5% each year.

How much risk you want to take also depends on your own appetite for risk and ability to tolerate the highs and lows of the market.

Help I’ve left it too late!

Many parents may feel that if they haven’t opened a Junior ISA in their child’s first few years, they will have missed the boat to do so.

Having a child is expensive, and understandably some parents won’t feel like they can afford to put aside extra money each month or year while they are still paying childcare costs, or are off on maternity leave.

If you’ve left it late, you haven’t missed your chance. Even if you only have five years until your child reaches the age of 18, that’s still time to amass a decent pot of money.

Say your child has reached the age of 13. If you open a Junior ISA for them on their 13th birthday and paid in £355 a month (taking you to the maximum £4,260 for the year), on their 18th birthday they would have almost £25,000 sitting in their account, based on 6% growth each year.

Even if you decided to leave the money in cash, as you need access to the money in five years, and earned 3% interest, you would have almost £23,000 on their 18th birthday.

If you have longer until your child reaches 18, you can save more and benefit more from the effect of compounding.

Someone who opened a Junior ISA on their child’s 7th birthday, and paid in £355 a month until they reached the age of 18 would have £136,000 on the child’s 18th birthday, assuming 6% growth a year. Even if you can only find a spare £100 to put away each month, you’ll have more than £38,000 on their 18th birthday.

Another thing to consider is that the money could stay invested beyond their 18th birthday. One of the downsides of a Junior ISA is that when the child reaches the age of 18 they become responsible for the money. This means they can withdraw it all and spend it, if they wanted to. However, if they don’t need the money (and you can convince them to keep it invested) it has the chance to grow further.

The same £25,000 pot that a child may have at age 18 can grow to almost £30,000 if they keep it invested getting a 6% return each year until the age of 21 – when they may have finished university, be starting their first job or thinking about getting on the housing ladder.

Find out more about our Junior ISA

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Laura Suter is Personal Finance Analyst at AJ Bell. She is a multi-award winning former financial journalist, having specialised in investments. Laura joined AJ Bell from the Daily Telegraph, where she was investment editor. She has previously worked for adviser publications Money Marketing and Money Management, and has worked for an investment publication in New York. She has a degree in Journalism Studies from University of Sheffield.