Money Makeover: "I want to save up towards a deposit for my first home"
Andrew Smith is 25 years old and works in London at Threadneedle Investments. He commutes to work every day from Tunbridge Wells, where he rents a subsidised room in a house owned by his local church.
He enjoys a reduced rent because he worked for the church as a youth worker for three years. His ultimate goal is to return to working for the church by becoming a vicar but, like many young professionals starting out, Andrew is keen to save enough money to buy a home, get married and start a family. He has managed to build up savings, supplemented by a small inheritance from a few years ago.
Andrew's primary objective is to save towards a deposit for his first home but he wants to make sure his existing savings grow faster than inflation – and ideally as fast as house prices. His savings are quite large for someone of his age, and he needs to ensure that he is able to achieve a steady rate of growth in order to maximise the size of his deposit.
Andrew met IFA Edmund Hastie to formulate a plan. Here's what the adviser had to say.
Andrew has a fixed-rate savings bond with Nationwide, which is about to mature with a current value of £20,000. He is likely to need a deposit of around £25,000 for a property and I would not recommend putting all of his savings towards this yet but instead ensure a suitable spread of investment exposure that will hopefully bring about growth across a variety of asset classes over the next two years.
For starters, he should set aside some of the money in a rainy day fund, around £2,000 to £3,000, which will help with any immediate payments needed upon purchase of the property, and ensure he has exposure to different asset classes. I would invest this money in a General Investment Account offered by, say, Nucleus.
This will give Andrew the best of both worlds because his monies are invested in equities and other investments, though if he requires cash urgently, his investments can be sold down to cash and the money wired to him. Andrew has easy access to the money and a portfolio built around his attitude to risk.This will give Andrew growth targeted to exceed inflation.
To ensure his rainy day fund can grow in a tax-efficient way, he must maximise his New Isa (Nisa) allowance every year. All growth within a Nisa (and previous years' Isas) is free from capital gains tax, so Andrew will not have to worry about any gain in excess of £10,900 in one tax year being eroded by tax.
There are a couple of quick fixes Andrew could also make to his existing investment portfolio to make it more tax efficient and help him build up a deposit. For example, he could transfer his shares into a stocks and shares Nisa so that any future growth is never taxed, helping him achieve a more tax-efficient growth strategy.
He could max out his Nisa allowance for the current tax year, which is £15,000 across any combination of cash and stocks and shares as he sees fit. He should also consider an actively managed stocks and shares Nisa, such as that offered by Brewin Dolphin, so that it has a chance to outperform the market, rather than merely tracking it. Such accounts in Brewin's Managed Funds Service have grown between 7% per year over the past three years for the most cautious fund, to more than 20% for the most aggressive fund.
Next, he should review the £13,750 he has in BT shares. I would diversify his shareholding into a balanced fund to prevent a significant loss, should shares in BT fall considerably.
A balanced fund will have a spread of investments in fixed income, bonds, cash and some equities to give the investor exposure to stockmarket growth. Rates of growth in cautious funds over the past few years do vary, though some providers have achieved about 7% per year on average.Two such funds Andrew could consider are Brewin's Balanced and Cautious portfolios, which have returned 24% or 32% over the past three years respectively.
From the Nationwide bond, Andrew could divide the remaining cash so that half goes into a balanced fund to give a reasonable rate of growth over time, and the remainder into a structured product.
As for the property deposit, I think he should put down 10 to 15% of the purchase price, which will result in him paying a lower rate of interest on his mortgage than should he opt for a 95% loan-to-value (LTV) deal many first-time buyers have to go for. Also, in a rising market, it will mean that his LTV will decrease quite quickly. For example, if he buys a flat in Tunbridge Wells for £200,000 with a £170,000 mortgage that would be an 85% LTV– so he would have to pay a deposit of £25,000.
Assuming the property increases in value by 10% to £220,000 two years later, when he comes to remortgage, then the LTV will have decreased. And if he repays £5,000 of the debt over the two years with a repayment mortgage, he would have reduced his mortgage to £165,000, so the LTV would be 75% rather than 85%.This will result in
the rate of interest falling from about 3.25% at 85% LTV to 2.5% at 75% LTV, based on current mortgage rates.
When applying for a mortgage, I would recommend Andrew take out life and critical illness cover (CIC) so he will receive a tax-free lump sum in the event of critical illness, or any beneficiaries will in the event of his death. At his age, a premium of £50 per month will provide a minimum of £150,000 of life and CIC. I would fix the premiums so they are guaranteed throughout the life of the plan, enabling him to take advantage of ‘locking in' low premiums.
Andrew also needs to start planning for his retirement. He should consider setting up a small monthly contribution towards a personal pension, say £100 per month, which will enable him to receive tax relief on his contributions.
If Andrew wants the greatest spread of investments, then I would recommend a self-invested personal pension (Sipp) to give him the greatest choice of funds – usually several thousand from a fund supermarket – and low annual management charge of 0.45%. Hargreaves Lansdown offers a competitive Sipp at present and has a strong financial record as well.
He should invest his pension money in accordance with his attitude to risk within a balanced managed portfolio as a way of beating inflation.
Andrew says: "Edmund's advice transformed my financial situation from one based on some vague ideas and low-yielding deposits into a fully-fledged and professionally managed investment portfolio."
How Andrew can plan for his financial future
- Set up a rainy day fund of around £2,000 to £3,000.
- Maximise his New Isa allowance.
- Aim to put down a house deposit of 15%.
- Start saving for retirement, possibly into a Sipp.
Original financial report conducted by Edmund Hastie, an independent financial adviser at Totus in London
A “traditional” mortgage, where the monthly repayments entail of repaying the capital amount borrowed as well as the accrued interest, so that during the loan period the capital debt is gradually paid off so by the end of the term the mortgage has been fully repaid. One advantage of a repayment mortgage is that it removes the risk of having a parallel investment (such as an endowment policy or pension), the performance of which is dependent on the stockmarket, such as with an interest-only mortgage.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Annual management charge
If you put money in an investment or pension fund, you’ll not only pay a fee when you initially invest (see Allocation Rate) but also a fee every year based on a percentage of the money the fund manages on your behalf. Known as the AMC, the actual percentage varies according to the particular fund, but the industry average for active managed funds is 1.5%.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.