Top tips for CTF investors

Any child turning seven in the next few weeks might be hoping for a new scooter, football kit or the latest games console, but as the first beneficiaries of the Child Trust Fund scheme, which went live in 2005, they can also look forward to an extra £250 from the Government from next week.

All children born on or after 1 September 2002 benefit from the scheme, which sees most receive £250 at birth (£500 for the lowest income families) and the same again at age seven.

But while this "free money" is not to be sniffed at - though statistics reveal that typically 19% of vouchers go uninvested - the real benefit of the Child Trust Fund lies in its ability to be topped up by friends and family.

With the minimum £500 (£250 at birth and £250 at age seven) invested, a 6% compound growth rate would see the tax-free fund rise in value to £1,246.88 by the child's 18th birthday. But assuming the same rate of growth, the maximum contribution (£1,200 a year or £100 a month on top of the Government's £500) could produce a fund of £40,175.88 - enough to help see the child through a university education.

It's no secret that stock market performance in the last few years has been volatile, but the beauty of the CTF is the length of its investment horizon. Even for those turning seven this year, there are still 11 years until their fund matures, which should hopefully be long enough to ride out any lumps and bumps in share values.

Jason Hollands, director at F&C Investments, a leading CTF provider, says: "Whatever recent stock market performance has been like, cash is perhaps not the best place to invest over the long term, as although your capital is secure, its real value will be slowly be eaten away by inflation. In contrast, we believe the best time to buy equities for the long term is often when markets have been through a tough patch."

The most recent Government statistics show that three-quarters of all Child Trust Funds are held in stakeholder schemes, typically UK index-tracking investments where annual fees are capped at 1.5%. But despite the fee cap, stakeholder CTFs are not necessarily the cheapest option. F&C Investments' non-stakeholder shares CTF offers a range of actively managed investment trusts, with the oldest and largest, Foreign & Colonial Investment Trust, attracting a total expense ratio of just 0.53% a year.

Many parents opting for an equity-based CTF choose to take advantage of their long-term horizon by choosing funds that might be considered more risky, but which have superior (though not guaranteed) growth potential. Among the 14 investment trusts on offer through F&C's non-stakeholder shares scheme (there is also a stakeholder scheme investing in a FTSE All-Share tracker), popular choices include Pacific Assets Trust and F&C Global Smaller Companies.

Since the CTF scheme went live in April 2005, the maximum amount (£5,450) invested in Pacific Assets Trust would have grown to £6,408, while in F&C Global Smaller Companies it would now be worth £5,550 - not too shabby over a period when sticking with the default UK index-tracking option would actually have lost you money. (Figures to 31 July 2009, Source: Lipper.)

Parents should remember that friends and family can pay into the CTF too, provided the £1,200 annual limit is not breached.

The F&C CTF allows investors to start, stop and vary their contributions at will, and with regular investments starting at £25 a month per trust, there are plenty of opportunities to build a diversified fund, or simply opt for a ready-made global portfolio such as Foreign & Colonial Investment Trust.

Hollands concludes: "While it's nice for the kids to have this autumn windfall in the shape of the vouchers that are about to arrive, the real measure of long-term success for Child Trust Funds will be the extent to which they are topped up, rather than the size of taxpayer handouts, as that will be the ultimate proof as to whether the nation's savings habits have changed."

Seven things to bear in mind as seven-year olds get CTF windfall

1 It's a good time to review your CTF strategy. Don't forget you can switch from one provider to another if you want - many parents are unaware of this.

2 Don't be disheartened by recent equity market performance. Investing in shares still offers the best growth potential over the long term, although there will be ups and downs along the way.

3 Don't assume stakeholder CTFs are the lowest-cost option. While in theory 1.5% a year is the maximum a stakeholder account can charge, in practice most charge exactly that. Investment trusts can offer active management at a fraction of the cost.

4 The world is your oyster. Many stakeholder accounts stick to tracking an index of UK shares, but the UK is only a modest proportion of global stock markets. Many other markets, while perhaps more risky, have superior growth potential, or you could ensure you have all bases covered with a diversified global investment trust.

5 Although cash might seem the safest option in these volatile times given that your capital is secure, the returns on offer tend to be poor. Interest rates are at a 300-year low and inflation - which is unlikely to stay in negative territory for too long - will eat away at the value of your fund over time.

6 Don't forget those children over 7 who have missed out on the Government's generosity. There are other children's savings plans available offering the same breadth of investment choice as a CTF, and with greater flexibility.

7 While inducements such as gift vouchers might look good at the point of opening a CTF, don't let them blind you to the real value of the investment. A good choice could make you much more than the value of a free piggy bank over the long term.