Junior Isas, which launched in late 2011, are a new phenomenon so many parents won't know what to do with the cash for their kids yet. They have two key choices: a relatively safe and simple cash Isa, or to gamble on the markets with an equity Isa. John Chapman (pictured, right), managing director of financial adviser firm TQ Invest, explains the difference.
Junior equity Isas look attractive compared to cash Isas now, because the rates paid on cash savings at the moment are so low.
Yes, the financial markets have been through a volatile period, but even when share prices are low, buying closer to the bottom means you could end up with a handsome return in years to come if markets pick up.
Money in a junior equity Isa is generally expected to outperform money saved into a junior cash Isa over the long term. But the road to higher returns may not be as smooth.
Investments are linked to the stock market in some way. You can save and invest up to £3,600 tax-efficiently every tax year (April to April) with a junior Isa in cash, equities or a combination of both.
Junior cash Isas are solid and reliable, and you are guaranteed to get back all of the money that you put in. But they have their own hidden danger of inflation.
To at least keep up with the rising cost of living, £100 saved today has to grow to be able to buy the same value of goods when the account matures.
In January 2012, the rate of consumer prices index inflation in the UK was 3.6%. To keep up with the cost of living, your cash Isa has to match this rate, which is not currently possible. Ideally, you need a bit extra on top.
Investing has risks
If you are locking money away for a long time — five years, at the very minimum — it is often better placed in an equity-based investment which can offer much higher potential rates of return.
Unlike with cash savings, money held in equities rises and falls in line with what is happening in the financial markets. In other words, the value of the investment can go up and down.
But by investing for a number of years — with a junior Isa this could be as long as 18 years — there is the timeframe to help smooth out these peaks and troughs, with the aim to produce good growth.
Investing into a junior equity Isa does not have to mean buying individual stocks and shares, which are very high risk. Instead you can buy into a fund, or you can buy into several different funds to make your own mini-portfolio.
The level of growth achieved from a junior equity Isa depends on the investment you choose. The rule of thumb is that higher risk investments can produce greater returns than lower risk, more cautious funds over the long term.
An investment fund is managed by an expert fund manager who buys stocks to hold in the fund. There are thousands of different types of investment funds to choose from, covering investments in the UK and globally.
There are charges when you invest into a junior equity Isa and these depend on the fund you choose. These are referred to as the 'TER' ("total expense ratio") and are expressed as a percentage figure next to the fund.
You can invest in different asset classes such as bonds, equities and property. You can choose one fund, or several to hold in a junior equity Isa.
When to invest?
People often wonder when the right time is to invest, but there is never really a 'bad time'. In fact, the worst thing you can do is try to outguess the stock market.
The best time to invest is typically when the stock market is low, but this can be a difficult decision for less sophisticated investors.
The best approach is to drip-feed money into your junior equity Isa. If you pay in regular monthly amounts, rather than a one-off lump sum each year, this helps to smooth out the 'market timing'.
Views expressed are not necessarily those of MoneySavingExpert.com.