A Junior ISA (JISA) is a popular way to build a tax-free pot of money for your child but many parents are opting for the safety of cash over the stock market and could be missing out on long-term gains.
HMRC data shows that while most JISA money is paid into stocks and shares, 61% of the tax-free savings accounts are cash versions.
While this may provide the safety of a regular return for a child’s nest egg, there are also risks to this approach.
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The top rate on a cash JISA is currently 4.95% from Coventry Building Society.
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That may be just above the current rate of inflation, but the purchasing power could soon dwindle if the cost of living measure rises.
Additionally, it may work out as a relatively poor annual return if putting money away until the child can access the account at age 18 compared with investing through a stocks and shares JISA, especially if the cash interest rate drops.
Sarah Coles, head of personal finance at Hargreaves Lansdown, warns that savers may overlook the fact that inflation can damage the value of their cash, and even though they may walk away with a larger lump sum, it could have less buying power than when they started.
“People tend to over-estimate the risk involved in investing,” she says.
“This is partly because they focus on short-term fluctuations – especially when they make headlines – so they miss the fact that over the long term there’s an opportunity to ride this out, so their money has a better chance of beating inflation.”
While investing does have risks, the returns are typically higher than what cash offers.
Analysis by Hargreaves Lansdown found that if you paid £100 a month into a stocks and shares JISA and made 5% a year for 18 years, you could end up with a nest egg for your child worth £34,920. If you paid it into a cash JISA and made 2.5% for 18 years, the pot would be worth £27,244 - £7,676 less.
Further analysis by financial planning firm Lumin Wealth for MoneyWeek found that contributing £125 per month over 18 years could create a JISA portfolio worth £43,700, based on a 5% return, or £261,900 if you maxed out the £9,000 allowance by investing £750 per month.
“JISAs are designed to cater towards a long-term investment horizon by their very nature, as they are ringfenced until your child turns 18,” says Jason Coppard, chartered financial planner for Lumin Wealth.
“An 18-year investment horizon means that you may be able to take on more financial risk, as there is plenty of time for strong returns to counterbalance the inevitable leaner years, and for the power of compounding – often known as the ‘snowball effect’ – to work its magic.”
Here is how to minimise the risks when investing through a JISA for your child’s future.
Invest for the long term
Investors typically need a time horizon of five to 10 years to ride out market volatility.
This makes the long-term nature of a JISA helpful, especially if you start as soon as the child is born.
“The 18 years of a JISA lend themselves to investment,” says Coles.
“It can make sense to revisit investments every few months, rather than checking up on them too often.”
Saving with a cash JISA rather than investing can be the right choice in some circumstances, Coles adds.
“If the child is an older teenager, or where the money is needed for something very specific at a particular time, and this is the only sum that will ever be available for it, it may be suitable,” says Coles.
“However, if you don’t fit into either of these categories, when you’re putting money aside for the long term, of up to 18 years, you really should consider investments. It offers far more potential growth than cash over this kind of time frame."
The importance of diversification
As with any investment, it is important to diversify.
“When it comes to minimising risk the same rules apply for Junior ISAs as adult investment accounts. You should avoid unusually high allocations towards single markets, sectors or securities, which is known as concentration risk,” adds Coppard.
“A well-diversified portfolio can substantially enhance long-term investment outcomes.
“Allocating money across a number of different asset classes helps to smooth out the ups and downs of portfolio values."
Coles suggests the easiest way to get diversification is to start with funds, but some parents may want a more hands-on approach by building their own portfolio of shares.
Drip-feed investments
Time rather than timing the market is often the most important aspect of investing so you don’t buy or sell at the worst point.
The easiest way to take timing out of the equation entirely is to set up regular payments into a JISA by direct debit, says Coles.
“It means that when markets have fallen, your money will buy more units, so you can benefit when they rise, and improve your investment gains over the long term. You can make payments from as little as £25 a month,” she adds.
Coppard says drip-feeding money into a JISA each month may provide some protection against markets falling sharply after the money is invested, although it can also work against you, as markets tend to go up more often than they go down.
“Successful investing is not about predicting the future, but having the right mix of assets and sticking to a disciplined strategy over the long term,” he says.
“Trying to time the market is one of the biggest investing pitfalls.”
