The economic downturn is damaging returns on Child Trust Funds (CTFs) for the first time since they were introduced three years ago.

Vouchers invested in equities have suffered falls after recent declines in the performance of the stock market, according to the Children's Mutual, one of the UK's biggest CTF providers.

The scheme was launched by the Government in 2005 to help to build a nest egg for children when they reach 18. All children born on or after September 1, 2002, receive a £250 voucher to start an account. This can be invested in equities, cash or both. Parents and other relatives are then allowed to top up the initial investment by up to £1,200 a year, while the Government will contribute a further £250 when the child reaches age 7.

CTF companies are telling parents of children with funds that have suffered declines over the past few months not to panic, because returns should pick up again over the 18-year term of the fund. David White, chief executive of the Children's Mutual, says that parents should resist the temptation to transfer their children's savings to cash accounts.

About 75 per cent of parents with children eligible for CTFs have opened more than 2.4 million CTF accounts since the scheme was introduced. The average monthly amount saved in a fund has increased from £15 to £24 over the period.

In last week's Budget Alistair Darling said that, from April next year, parents would be able to open a CTF account over the phone or the internet to make it easier to invest. At the moment, the voucher is invested on the parents' behalf if they have not posted the voucher within 12 months, but this means that the child misses out on a year of interest payments.

Mr White says: “We have experienced an increase in the number of calls from parents who are worried that their annual statements are showing a fall in value. However, we are explaining to them that, because the investment is for the long term, the fund will still do well over the 18 years.”

Moreover, parents who continue to make monthly deposits into their children's funds during the stock market downturn will actually be better off when their investments mature. This is because they are buying units of equities at a cheaper price, giving them more shares for their money, thereby increasing their returns when share prices recover. This effect is known as pound-cost averaging.

Despite the likelihood that share accounts will offer higher returns than cash accounts over 18 years, the interest rates on cash CTFs look positively mouthwatering at the moment. Moneyfacts.co.uk, the financial website, says that Hanley Economic Building Society offers the best cash CTF on the market, paying 8 per cent. Close behind are Britannia Building Society (7.25 per cent), Chorley & District Building Society (7 per cent) and Yorkshire Building Society (6.8 per cent). These compare well with rates of about 6 per cent when CTFs were introduced.

However, the amount that children end up when they reach 18 depends entirely on whether parents make additional deposits after the initial investment. Concerns have been raised that the scheme could contribute to wealth inequality among teenagers when the first set of recipients turn 18, because of differences in how much parents invest.

Figures from the Children's Mutual show that a £10 monthly contribution into a stakeholder fund will grow to an estimated £4,700 by the time a child is 18. Investing an extra £50 a month will generate an estimated total of £19,100, while the maximum monthly contribution of £100 would grow to £37,100 over 18 years. The idea is that children then use the money either to help to save towards a deposit for a house or to help with the cost of higher education.

Mr White says believes that CTFs could help to resolve the UK's continuing debt crisis. “For too long the answer to too many things has been to borrow more,” he says. “This scheme is a clever catalyst to changing this way of thinking.”

CASE STUDY: Fair share for kids

Cheryl and John Fairclough invest £10 a month into Child Trust Funds (CTFs) for each of their children, Cameron, 6, and Carter, 3, Lauren Thompson writes.

The Faircloughs chose the Baby Bond Choice non-stakeholder CTF from the Children's Mutual in the hope of better returns than a cash investment. “As it is a long-term investment, we preferred to opt for an equity-based fund,” Mrs Fairclough says. “They did well in the first couple of years, but are doing less so in the current stock market turmoil. However, they have years left to pick up.”

Explore Money

• Property & Mortgages

• Savings

• Borrowing

• Investment

• Funds

• Insurance

• Consumer Affairs

• Tax

• Pensions

• Broadband