Hello
With £2.5k and a 2 year old with decades ahead of her/him I'd avoid interest bearing [bank] investments and National Savings and invest the money in high quality dividend paying shares or a dividend paying exchange traded fund. Once you've done this, set up the dividends to be automatically reinvested to purchase additional shares and over time the compounding will be astounding.
To give you an idea of what might happen, if you chose a shares in a company like Vodafone which has historically paid a good dividend and has raised its dividend pretty much every year excluding the impact of any tax. However tax should be easily avoidable for your child even if the money isn?t sheltered in an ISA until the child is eligible at age 18. As long as the return on investment doesn?t exceed £100 per parent in the first year [all subsequent second generation gains ? i.e. gains on gains don?t? count]. So you and your spouse each give your child half of the money and going forward your child won?t pay tax until the income exceeds the basic tax threshold of £7475 for tax year 2011-12. By the time the income is taxable your child will be able to move the money into a shares ISA to shelter it from tax assuming ISA?s still exist in 16 years.
Here is how it might play out if you simply invest the £2.5k and add nothing else over time. Assuming the shares yield 5%, they appreciate at 3% per year and the dividend increases annually by 8% [there are plenty of shares that have these figures].
When you child is 18 [16 years from now], the investment would be worth about £12,500 and paying dividend income of nearly £1,200 a year, at age 30 the investment would be worth about £92,000 and generating dividend income of about £14,500 a year and at age 40 the investment would be worth £1.18 million and generating a dividend income of £280,000 a year.
The key to this is choosing shares that pay a dividend and that increase the dividend ever single year. You can set-up the investment account with a broker like TD Waterhouse and for a nominal fee the dividends will be reinvested. If you can afford to contribute to the fund every month - even just £25 or £50 ? or money from relatives, it will grow even faster. If you teach your child about the value of investing and maintaining his/her nest egg, even after inflation, your £2.5k could easily be enough to set your child up financially for life.
See www.childmillionaire.com for more information. There is a free calculator to run your own numbers and an ebook that explains all of this in detail.
Good luck with it!
you wouldn't have your own little private list of what stocks you believe are currently undervalued and\or pay out the best dividends?