Give a child cash to invest for Christmas, rather than just toys

Investment trusts and Oeics (open-ended investment companies) can make excellent Christmas presents for children – just don't expect to be thanked if they were hoping to unwrap a Nintendo Wii or the latest Power Rangers action figures on the big day.

Although a six-year-old is unlikely to be swayed by arguments that the cash could be used as a deposit on a house when they're older, they will thank you when the time comes. In fact, £1,000 put into the average investment company back in 1987 would now be worth £4,850, while saving £50 a month over the same period would have created a £24,108 nest egg, says the Association of Investment Companies (AIC).

Annabel Brodie-Smith, communications director at the AIC, believes these figures make a compelling argument in favour of giving financial gifts.

"All parents want to make sure their children have a great Christmas with a lot of toys, but an investment company could make a real difference to a child's financial future," she says.

So what are your options?

If they haven't got a bank or building society account then opening one up in their name will encourage a child to start saving. There is plenty of choice so take your time, says Kevin Mountford, head of savings products at Moneysupermarket.com. Look at the headline interest rate and consider how easy it is to get access to the money.

"It is a disciplined way of putting money aside on behalf of the child and they will thank you in the future for getting them into good habits," he says.

The next move is investments. Arguably, the simplest and most effective route is to add money to the recipient's Child Trust Fund – the tax-free savings vehicle for all children born on or after 1 September, 2002. These can be considered ISAs for children, says Andy Gadd, head of research at Lighthouse Group. "Anyone can pay money into a child's CTF account and £1,200 is permitted each year," he says. "The year ends on the child's birthday – not the tax year-end – and unused amounts can't be carried forward."

Choose your CTF carefully, says Darius McDermott, managing director of Chelsea Financial Services.

"The drawback is you tend to be restricted to the funds offered by a particular provider," he says. "We use the Children's Mutual, which do have access to a mixture of groups and managers but the choice is limited."

Those who have reached their annual limits – or are too old to own a CTF – can still benefit from pooled investments such as unit trusts, even though under-18s aren't allowed to hold them, says Geoff Penrice at Bates Investment Services.

"It is possible for adults to put such investments in a 'bare trust' for a child," he says. "The tax will be chargeable to the beneficiary and, as children are generally non-taxpayers, the proceeds will effectively be tax-free – other than the 10 per cent withholding tax on dividends that can't be reclaimed."

Where gifts from a parent produce more than £100 gross income a year, the whole of the income from the gifts is taxed as the parent's income. A child cannot claim back any tax on that income. Nor can interest be paid without tax taken off. Therefore, larger gifts need to be made by grandparents, other relatives or friends, as the £100 rule won't apply to them.

Other investment products worth considering are Index-Linked Savings Certificates and Premium Bonds, available via National Savings & Investments. The former sees the value of the investment increase in line with inflation as measured by the Retail Prices Index (RPI) and earns guaranteed interest rates on top – with all the returns tax-free. The latter can be bought on behalf of under-16s by parents and grandparents with a minimum investment of £100 and a maximum of £30,000. Although no interest is paid, the bonds are entered into monthly prize draws.

Andy Gadd is unenthusiastic about Premium Bonds. "They are a gamble, with each bond having an equal chance of winning a prize but no guarantee of doing so," he says.

Each type of investment has its benefits and pitfalls. "When considering the various investment opportunities available for children it is important for a parent to consider the level of risk, tax efficiency and access to the money," he adds.