A Junior ISA or Junior SIPP (Self-Invested Personal Pension) can give a child a massive financial head start in life. I’m not exaggerating when I say these accounts can potentially set up a child for life.
It all comes down to compounding, which is the secret to building long-term wealth. Let me explain.
The sooner you start compounding the better
Compounding is the process of earning a return on past returns. Over time, it leads to exponential financial returns because of the ‘snowball’ effect (your money starts making money, and then that money makes money etc).
The problem is, the majority of people miss out on the first 20 years or so of investment compounding. Generally speaking, most people don’t start investing until they’re at least 20 (ie when they start work), which means they’re missing out on huge potential gains.
This is where Junior ISAs and Junior SIPPs come in. With these accounts, parents can put money away for their children from birth so they can benefit from compounding in the first 20 years of their lives (and beyond) tax-efficiently.
The results can be incredible. For example, if a parent was to put £5,000 into a Junior ISA today for a new-born baby and was able to generate a 9% return a year after fees, that money would be worth almost £30,000 by the time the child turned 20 (by 50 it would be worth almost £400,000).
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Investment vehicles for children in the UK
It’s worth noting that in the US, the government has acknowledged the benefits of compounding early on in life and taken action. Recently, it launched ‘Trump accounts’, where children born between 2025 and 2028 receive $1,000 in an investment account (the money is invested in the S&P 500 index).
We don’t have this kind of thing in the UK at the moment. But Junior ISAs and Junior SIPPs are good alternatives – both allow money to be put away for children and for the money to grow free of capital gains tax and income tax.
An investment to consider
I’ll point out that with these two types of accounts, parents are responsible for investing the money. Performance will depend on the investments selected so parents need to invest thoughtfully.
Get it right, and the returns could be excellent (eg 10%+ a year). Get it wrong however, and the returns could be ugly (ie negative).
Personally, I think a good place to start is a diversified growth fund such as the Scottish Mortgage Investment Trust (LSE: SMT). There are a few reasons why.
First, with a product like this, investors get exposure to industries that are likely to see strong growth over the next few decades. I’m talking about industries such as AI, robotics, FinTech, and space.
Second, investors’ money is spread out over many different companies. So stock-specific risk is mitigated (meaning it’s far less risky than investing in individual companies).
Now, funds that are focused on growth/tech stocks tend to be volatile. And this is a risk here – in recent years the Scottish Mortgage share price has swung around wildly at times.
Children can afford to take on risk in the pursuit of higher long-term returns however, as they have time to ride out volatility. So I think this trust – which has an excellent long-term track record – is worth considering.
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Edward Sheldon owns shares in Scottish Mortgage Investment Trust
