FOOL'S EYE VIEW
Blair's Baby Bonds

By Christopher Spink
April 27, 2001

Roman Emperors in a spot of bother used to quell the mob by giving them a free supply of corn for a time. This handout was dubbed the dole. Sounds familiar doesn't it? Similar payments have been made at political sensitive times throughout history. This power-preservation technique isn't lost on our present-day political leaders either, particularly in the run-up to a General Election.

Yesterday Tony Blair unveiled a scheme whereby every newborn baby in the country will receive a sum up to £500, which will mature when the child reaches 18. This trust fund will be topped up with further £100 payments at the ages of 5, 11 and 16. The idea is that this money, which could, if invested properly, be worth £2,000, will give youngsters a good start in life. These funds have quickly been called "baby bonds".

Baby kissing

This is radical thinking for a Government. Normally the state taxes its citizens a certain amount then uses the money raised to provide public services. It's strange that New Labour wants to keep taxing people and hand back some cash at the same time, in the form of tax credits and one-off payments. It sounds terribly complicated, pretty inefficient and, because of its timing, a blatant election ploy.

Indeed, delve into the details of the scheme and they still appear very sketchy. Accompanying the Prime Minister's speech yesterday was a consultation document, which asked more questions than it answered. Nobody knows exactly how the scheme will be administered; how the money can be invested; what restrictions there are on spending it when the trust matures; or which babies qualify for the full £500.

Baby bonds will be means-tested. Children of parents on lower incomes will receive £500 at birth followed by £100 on sixth, eleventh and sixteenth birthdays -- a total of £800 in all. These amounts would be halved for parents who earn above a threshold level. Perhaps a sensible way of splitting those who get £500 from the rest will be saying if the parents pay only the basic rate of income tax they get the higher baby bond.

But the sketchiness of the proposals means that, assuming Labour get voted back in, the system won't be up and running for at least two years, if not longer. After all, stakeholder pensions have only just been introduced despite proposals being put forward at the start of the present Parliament. Thus beneficiaries of baby bonds won't actually get the cash for 20 years.

Long-term thinking?

That's a long time. At least that should focus parents and children on the benefits of taking a long-term approach to saving and watching money grow. An accompanying scheme, called a Savings Gateway Account, will allow adults on low incomes to save up to £1,800 over three years. The Government will match each pound saved with a pound of public money. The fund can then go into the baby bond, pension or ISA.

How much will the baby bonds be worth when they mature? If you assume a growth rate of 5% after inflation the £800 would be worth around £1,600 by the time the child turns 18. If you assume a rate of 7%, nearer the long-term returns of the UK stock market, this rises to around £2,200.

Hang around, that's hardly a lot, working out at roughly a tenth of the £22,000 average annual wage. Most of this money should go for educational purposes. At the moment a third of 18-year-olds go on to university. The Government hopes that a half will do some form of tertiary education within a decade. Student tuition fees work out at £1,000 a year. So this trust money will on maturation pay for two years' university tuition.

A Mintel report out today says that 60% of people under 26 in Britain are now in debt. Those aged 20 to 25 are more likely to have greater debt, with almost a quarter of this group owing £3,000 or more. So it seems that baby bond money will be best spent by youngsters in avoiding the debt trap. This report suggests that a lot of these young people aren't too concerned about debt and are unaware of its pernicious effects.

Life-time learning?

However, if you know you have money coming in at the age of 18 then you should become aware of the value of money. Gifts from family and friends may also be able to be put in the fund, possibly tax-free. To see the snowball effect of compound interest at work would be both encouraging and educational. Having a focus would help focus young minds and show people how saving and investing works.

Given that as a nation we are currently saving less than 5% of our disposable incomes, with a staggering 16 million having no savings at all, then any attempt to explain the benefits of long-term savings has to be welcomed, even if the details are sketchy.

Ideally, we'd like to see the Fund invested in equities and regular updates provided on progress, combined with education on the long-term nature of shares. As you might suspect, we think that a plain old index tracker would be an ideal default option, although the fact that much of the money is invested at one time is not that desirable.

But all in all it's good to see politicians thinking about the long-term for once, even if it's for the short term purpose of bribing people to the ballot box.

Where Next?

Fool Book: Make Your Child A Millionaire 
Fool's Guide to Investing For Children