Cash on delivery: save before they're on solids

In the first of a series on investing for children, Clare Francis finds that a little money put by now can make a huge difference to your baby's future

It used to be a luxury, but as the cost of further education spirals, saving money for your child's future is becoming a necessity. Estimates from the Children's Mutual friendly society suggest it will cost around £33,000 a year to go to university in 18 years' time.

And even if your children don't aspire to academia, they may struggle to get on the housing ladder when they reach adulthood. Money put by now could help them meet the cost of their first home.

"The sooner you start saving for your child, the better," says Annabel Brodie-Smith, communications director at the Association of Investment Trust Companies (AITC). "For example, an extra two years can make a big difference. If you had started investing £50 a month in the average investment trust 16 years ago, you would now have £13,646. However, if you had started putting by £50 a month two years earlier, you would now have £18,315 – nearly £5,000 more."

The Chancellor's announcement in this year's Budget that every child born since last September will receive money from the Government is designed to encourage parents and relatives to start saving. Although the exact details of the child trust funds have yet to be revealed, each child will receive at least £250 at birth, and those from poorer families will get £500. Friends and relatives will then be able to contribute a further £1,000 a year which is expected to be either tax free or to have some sort of tax incentive attached. The Government will top up the funds, adding something like £50 or £100 when the child is five, 11 and 16.

However, while all babies born since September will benefit from them, the funds aren't likely to be introduced until 2005. And as the AITC figures show, holding off for two years after a baby is born before you start saving can make a big difference. So what else can you do to provide for your child's future?

Equity investments are ideal for children because over the long term – in this case, 18 years or so – it is likely that the returns will far outweigh those you would receive from a building society account. But this doesn't mean you should go for one of the plans that are specifically marketed for children, such as Invesco Perpetual's Rupert Bear fund, Aberdeen's Thomas the Tank Engine scheme or the Witan Jump fund. "Be careful," warns Michael Owen, managing director at independent financial adviser (IFA) Plan Invest. "The packaging isn't important – you've got to look underneath and see what's there."

While some IFAs do recommend Jump, the performance of the Rupert Bear fund has been very poor. Invesco has replaced the fund manager but it's too early to say if there will be a turnaround.

However, when setting money aside for children, parents have plenty of room for manoeuvre. They can choose from any unit trust, open-ended investment company (Oeic) or investment trust.

"Rather than invest in a special children's fund, why not buy them a cuddly toy and invest in a good fund?" says Anna Bowes, savings and investment manager at IFA Chase de Vere. "It's very easy to put a unit trust into a child's name – you just need to write the child's initials in the appropriate area on the application form." Known as a bare trust, this investment legally becomes the child's when they're 18, so if you'd rather keep control of the cash and pass it on when you feel the time is right, you may prefer to keep it in your own name.

Even though time is on your side if you invest in equities, you shouldn't take your eye off the ball. For example, to protect your cash against any sudden lurch in the markets, you may need to switch to a lower-risk fund in the few years before your child is due to go to university.

Most IFAs recommend sticking to a solid UK or global fund when investing for children. Philippa Gee at IFA Torquil Clark likes distribution funds, such as Jupiter's, as these have exposure to both bonds and equities. She also likes the Martin Currie UK Growth fund and Fidelity's Wealthbuilder. Mr Owen recommends Cazenove UK Growth and Income and Fidelity Special Situations.

Vivienne Starkey, managing director at IFA Equal Partners, suggests that, instead of investing in just one fund, parents build up mini portfolios for their children to provide diversification and spread the risk.

Following the launch of stakeholder pensions two years ago, it is now possible to invest in a pension for your child. You can pay in up to £3,600 a year, and while they won't be able to get hold of this money until they reach 50, it will make a huge difference. Figures from Chase de Vere show that if you invested the full £3,600 a year in a stakeholder from the time your child was born until they were 18 (assuming 7 per cent growth), the fund would be worth £882,652.82 by their 50th birthday.

Other alternatives include National Savings, a traditional children's favourite whose security compensates to some extent for their low rates. The current child bond, issue 6, is a five-year plan that has a fixed interest rate of 3.35 per cent. The maximum investment is £1,000.

Meanwhile, friendly societies offer bonds that allow you to invest £25 a month tax-free, although IFAs tend not to recommend them because the charges can be quite high. If you do decide to take this route, Ms Bowes recommends one of the bigger societies, such as the Children's Mutual or Liverpool Victoria.

Next week: children's accounts