We had this question from a reader which, is one of the more common questions we receive at Boring Money:
"I wondered if you could help with a query I have on some capital we have set aside to pay for school fees. We are currently paying for one son and have another who will join in 2 and a half years.
At the moment the money is sitting in our bank account earning ziltch. I don’t want to invest this in the Stock Market but would like to earn a little interest.
Would you have any ideas?"
This is a dilemma facing so many people at the moment. They don’t want to take any risk with their money, but they’d like to earn a little bit more interest. Unfortunately, with interest rates at 0.25%, that’s not easy.
If you really, really don’t want to risk losing a single penny, then all you can do is shop around for the best deals. You will tend to get a higher rate if you tie your money up for a bit longer – try fixed rate bonds, or if you invest through an ISA, see our Best Buys here.
Another option is to check whether your school offers an ‘Advanced fees’ scheme. This can offer a return of around 3-3.5% in exchange for paying a set number of terms’ fees upfront. Attached as an example is the Royal Hospital School’s scheme. Of course, your children have to attend the school before you can participate, but it may work for your older son.
Jason Broomer, head of investment at SquareMile research group suggests that another option might be to buy a government bond. These can be bought through the Government’s debt management office or through various broker sites. A five year gilt pays around 1.75% and you get your money back at the end (providing the UK government doesn’t go bust). Longer-term gilts will pay a little more.
You could also buy a corporate bond. The principal is the same as for a government bond – you lend money, you get interest, you get your money back at the end – but you are lending to a company rather than a government, which are at greater risk of going bust. Nevertheless, you can lend to well-established companies such as GlaxoSmithKline or John Lewis. The interest rates are higher to reflect this greater risk.
You could invest in a number of bonds to spread the risk, or you could invest in a corporate bond fund, which pools your money with those of other investors to buy a basket of these bonds. Don’t be lured by very high yields – these will usually mean greater risk, but many pay a decent 2.5-3.5% income. You have to accept some risk to your capital. In the financial crisis these funds dipped by as much as 20%, though they have more than recovered since.
Also, I wouldn’t dismiss the stock market outright. Yes, there can be chunky losses, but if you have a 5-year time horizon, markets usually recover. In the meantime, they remain a good source of income – the companies in the FTSE 100 index pay an average income of almost 4%. Perhaps more importantly, this income is usually inflation-protected – because companies can grow their profits, and therefore their dividends in line with inflation. Private schools can be pretty cavalier with their fee increases, with some rises well ahead of inflation.
Tim Cockerill, head of research at wealth management group Rowan Dartington, says: “School fees are pretty huge, so if you are looking at paying them from investment income, you need a chunky pot to start with. You also need to build in some kind of inflation proofing.” He suggests some of the lower cost, steady-eddie global growth investment trusts, such as Bankers Investment trust, RIT Capital Partners or Scottish Mortgage. These will spread your capital across a broad range of investments, meaning you are less exposed to sudden stock market shocks.
Of course, the right option is probably a combination of all of these. Perhaps you could think about a longer term pot and a shorter term pot. The longer term pot could be in higher risk areas – corporate bonds or the stock market, while the shorter-term pot could be in areas such as gilts or savings accounts.
I hope that helps. You’re in a really great position to have savings up front – most people pay school fees out of the income every month, which is a pretty painful way to do it!