Many American families already embrace the concept of a college fund and start saving for their children from when they are born.

With the cost of university increasing in the UK, lots of parents might be thinking of starting a similar fund for their children.

Anyone with younger children could start putting money away so their son or daughter can avoid having 40 years of student loans following them around.

If you start when your child is born, or in the first few years of their life, the money will have a long time to grow and benefit from compound growth.

HOW MUCH DO YOU NEED TO SAVE?

Currently the average graduate leaves university with around £45,000 of debt. This could be higher for future graduates as the cost of university rises and the size of loans increases too.

For that reason, we’ve taken the £45,000 figure and increased it by 2% inflation a year to see what the average sum is likely to be when a child reaches 18.

For a child who has just been born the amount will be just over £64,000. For a child who is five it will be just over £58,000 and for someone who is 10 the amount will be almost £53,000.

If we then look at the amount you need to save each year, it varies dramatically by the timeframe you have. Someone who starts saving as soon as their child is born will have to reach a higher sum but will have 18 years to save and benefit from compounding. That parent needs to put away £2,200 a year, or £183 a month, assuming they get an investment return of 5% a year.

A parent of a five-year-old who starts saving will need to put away £3,150 a year or £263 a month to be able to pay for their child’s university, while someone who waits until the child is 10 needs to save a much higher £5,250 a year, or £438 a month.

WHERE MIGHT I WANT TO INVEST?

If you’re saving for up to 18 years, then putting the money in cash doesn’t really make sense.

Currently the money would struggle to keep pace with inflation, and it means that you’d have to save more each year to get to the desired pot size in the future. Instead, someone who has an 18-year period to invest has the ultimate long-term investment time horizon. Taking more risk could reward them with higher returns.

Parents should make sure they put the money into an ISA, so it’s protected from tax on any gains they make from the investments.

There are two choices: open a Junior ISA in their child’s name or put the money in their own ISA – there are some pros and cons of each.

If you open a Junior ISA in your child’s name, then you can put in up to £9,000 a year and it will be sheltered from tax.

You (and grandparents/anyone else) can keep adding money but it is locked up until the child turns 18, at which point they legally control the money and can decide what to do with it. This means they could decide to splurge the money rather than spend it on university – although you’d hope not.

If you’re worried about your child having control of the money at age 18 you might want to save via your own ISA. It’s not as neat because the money isn’t ringfenced, and it also means you’ll have to use up some of your own £20,000 a year ISA allowance – which might be an issue if you plan to save up to that limit each year for yourself.

However, the money will stay in your name and won’t come under your child’s control on their 18th birthday. There’s no right answer, just what works for you.

Just remember that if you save into a Lifetime ISA, you’ll have to pay a 25% exit penalty upon withdrawal unless the money is being used for a deposit on a first property, you are aged 60 or older, or you are terminally ill.

WHAT IF THINGS CHANGE IN THE FUTURE?

A potential downside of starting a college fund at birth is that you have no idea if in 18 years’ time your child will want to go to university.

What’s more, you don’t know if the entire system will change (either to become cheaper or more expensive).

Because the money would be saved in an ISA account (whether it’s a Junior ISA or an ISA for adults such as a Stocks and Shares ISA) it isn’t ringfenced for a specific purpose. You could decide to use the money for something else, such as supplementing their income if they go into a trainee role on a low salary or helping with some    training.

The other potential downside is that most parents only have a limited amount of money they can save each month, so any cash they are funnelling into a college fund is money they won’t be saving for other purposes, such as towards a house deposit for their children. But the main thing is getting started with investing – you can always decide later how the money is spent.

Three potential investments for your university fund

Fidelity Emerging Markets Fund (B9SMK77)

Emerging markets are a higher risk area in which to invest but could see higher returns over a long time period.

One option is the Fidelity Emerging Markets fund, which invests in around 60 different companies across emerging markets, with current holdings including Samsung Electronics and HDFC Bank.

The fund doesn’t stick too closely to its target benchmark, the MSCI Emerging Markets index, which means returns can considerably differ from it at times.

Abrdn Global Smaller Companies Fund (B777SP3)

Smaller companies are another area that tend to deliver higher returns over a long period, albeit with a more volatile ride along the way.

One fund that invests in global small companies is Abrdn Global Smaller Companies – until recently known as ASI Global Smaller Companies. 

The fund typically has stake in between 40 and 80 companies around the world, with current holdings including payroll company Paylocity (PCTY:NASDAQ) and swimming pool supplies expert Pool Corp (POOL:NASDAQ).

iShares MSCI World SRI UCITS ETF (SUWG)

Many parents may want to invest ethically for their children’s future, and there has been a boom in the number of ESG funds launched in recent years.

Parents could opt for a tracker fund, such as the iShares MSCI World SRI UCITS ETF, which tracks the performance of the MSCI World SRI Select Reduced Fossil Fuel index.

This is effectively a basket of shares featuring companies with high ESG credentials and excluding companies such as oil and gas firms. The ETF costs 0.2% a year.

DISCLAIMER: Daniel Coatsworth, who edited this article, has a personal investment in Fidelity Emerging Markets Fund and Abrdn Global Smaller Companies Fund

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