Invest for success in 2016
Will 2016 be the year you finally get around to putting money into stocks and shares? Alternatively, perhaps you’ve made a New Year’s resolution to whip your existing portfolio into shape.
Investing in the markets can be rewarding, especially if you are saving for the long-term - at lest five years, and typically much longer.
But it can at times be confusing; it carries a certain degree of risk; and there are a number of potential pitfalls to watch out for.
This guide aims to cut through the jargon and complexity to explain everything you need to know, whether you’re taking your first steps in investing or trying to make the most of existing holdings.
Investing for beginners
If you are completely new to investing, the first step is to work out whether putting money into the markets is right for you, based on your current financial situation and goals.
“There are many reasons why people need to save and invest,” says Jason Hollands, managing director of investment firm Tilney Bestinvest. “It could be to accumulate a deposit to get on the property ladder or, indeed, pay off a mortgage; to build a pot of assets for your children’s future education needs; or, most importantly of all, to see yourself financially secure during retirement.”
Hollands explains that rising longevity and improved health in old age, coupled perhaps with less generous state and company pension provision, mean that more financial resources are needed in later life. “Most people underestimate the scale of this – so building up a pool of long-term investments, whether through pensions, Isas [individual savings accounts] or other means is vital.”
Patrick Connolly, a chartered financial planner at independent financial adviser Chase de Vere, adds that not everyone is in the right position to invest.
“You should make sure that you have paid off any expensive debt and have enough money in cash to cater for any short-term emergencies or requirements. This will stop you going into debt or cashing your investments in at the wrong time if you need to get hold of some money quickly.”
Assess the risk
Connolly also says that shares are unlikely to be appropriate for short-term saving. “If you are investing over a short time period, certainly less than five years, then you should stick to cash, even though interest rates are currently at historically low levels. This is because if you invest in the stockmarket and it falls in value, you will have very little time to make back any losses.”
Returns from investing in the stockmarket have in the past tended to outperform cash savings accounts over longer periods of 10 years or more. But, unlike a deposit account, where the first £75,000 of your money is safeguarded by a government guarantee, stocks and shares carry the risk that you could lose some, or even all, of your capital.
There are a number of strategies, however, that can be employed to reduce or minimise this risk, as we explain here.
When deciding how to invest, you need to be clear about your goals, Connolly says: “As a starting point you need to decide what you want to achieve, how long you are planning to invest for and how much risk you are prepared to take. This will help you decide the most appropriate investments for you.”
If you don’t have a lot of spare cash, putting a little money aside each month can be worthwhile. “The sooner you start saving, the easier it will be to reach your financial goals,” Connolly says. “Even if you cannot afford to save much initially, it is better to do something than nothing.”
Hollands adds: “In the world of investing, the first pound you invest is the most valuable. That’s because long-term investing is all about time: the longer you have, the more time your investment has to grow, so the earlier you start, the better.”
Most experts agree that, for beginners at least, buying shares in individual companies is not the best approach.
“While some people enjoy researching individual companies and choosing their own investments, this is a daunting prospect for most of us,” says Hollands. “To do this confidently, you need to be prepared to understand reports and accounts, watch the progress and news from a business carefully and decide when it might be the right time to sell. And it can be very risky if a company runs into problems.
“That’s why most investors access stockmarkets through funds – investments where your cash is pooled together with lots of other investors’ money and the combined firepower is used to take stakes in lots of different companies.”
This pooled approach has two major benefits: firstly, as investment fund managers effectively buy shares in bulk on behalf of thousands of people, their average trading costs are lower.
And secondly, holding a fund with a large range of companies reduces each investor’s overall risk through diversification.
“Diversification is an important principle in the world of investing and this is really about not having all your eggs in one basket,” Hollands says. For example, it is less likely that a portfolio of 50 companies will experience a sudden fall in value than one consisting of just two or three firms’ shares.
It is possible to diversify further by putting money into other assets such as corporate bonds – which are effectively a type of loan that pay holders a fixed rate of interest – or property. This can also be done via investment funds.
Funds also make it simpler to give your portfolio international exposure by investing in overseas companies and markets.
Types of funds
Your main choice when it comes to picking a fund relates to its approach to investment, Hollands says. “The investments within funds can be chosen by an expert, called a fund manager, based on research and their judgement over which businesses they believe will perform well. This is known as an ‘active’ fund.
“Alternatively, money can be automatically invested by a computer in a basket of shares to replicate an overall market – such as the FTSE 100 – with a type of lower-cost fund called an index tracker or ‘passive’ fund.”
Hollands warns that anyone going down the active route – which is likely to incur higher charges than the tracker option – should give careful thought to which fund they opt for.
“If you are going to trust a fund manager rather than a low-cost tracker, then it is vital to select the right fund – while some managers have great track records, others simply haven’t justified the fees for their ‘skills’,” he says.
“But if you are in a fund with a manager who proves successful, they should be able to deliver much better
returns by buying and selling shares as their views and markets change than you could as an amateur on your own.”
Connolly says that using recent performance as a guide to picking a fund can be a bad idea. “Don’t get swayed by investments just because they are at the top of the performance tables,” he says. “Strong recent performance should be seen as a warning sign, as investment gains have already been made – rather than as an opportunity to buy.”
The most common types of funds are unit trusts and open-ended investment companies (OEICs): investors buy units or shares, respectively, in these funds direct from whichever investment company runs them. Investment trusts also pool investors’ cash to buy shares and other assets – but shares in these vehicles are bought and sold on the stockmarket.
Within these fund types, there are further labels that reflect the approach taken by the relevant investment manager.
These could be sector specific – for example, a UK technology fund – or might instead focus on a single country or region, say Japan or Latin America.
“First-time investors should usually avoid higher-risk or more specialist investments unless they fully understand the risks and are prepared to take a long-term perspective, say, 10 years or more,” Connolly adds.
Each fund comes with a lot of information for prospective investors, covering the investment approach as well as a guide to the level of risk attached.
Hollands says that a relatively new class of fund is worth considering. “For a small investor just starting out with a modest amount of money, an efficient way to achieve diversification can be through investing in a ‘multi-asset fund’,” he explains.
“These are funds that themselves invest in a wide selection of underlying funds, typically from between a dozen and 20, picked by a team who then adjusts the mix periodically. From about £50 a month, a multi-asset fund could provide you with exposure to lots of funds, lots of markets and literally thousands of underlying companies held within them.”
Advice and information
While novice investors may welcome expert guidance, it is unlikely to be cost effective for anyone investing relatively small monthly premiums to pay for independent financial advice, Connolly says.
He explains that a lot of guesswork can be taken out by simply choosing the default fund in a company pension scheme, for example, or by opting for a global equity fund or index tracker.
“But if you’re investing a larger amount or as the size of your investment portfolio grows, then it could be sensible to take independent advice.”
The services you can use to buy funds also have a lot of information and recommendations to offer at no cost: sites run by Hargreaves Lansdown, BestInvest, Fidelity and Moneywise’s parent company, Interactive Investor, highlight popular funds and suggest portfolios that could suit investors depending on their attitudes to risk.
Another way of reducing investment risk is by drip- feeding money into your portfolio, a process known as ‘pound-cost averaging’.
Connolly says: “If you are starting out, then look to invest regular premiums on a monthly basis rather than putting in a lump sum. By investing regular premiums, you negate the risk of market timing because if the stockmarket goes down you simply buy at a cheaper price the following month.”
If, on the other hand, you were to invest a single lump sum every year, you would run the risk of buying just before a sharp fall in the market and suffering an instant loss of capital.
Hollands adds: “Regular saving is also a great discipline to keep on going through the good times and the tougher times, which helps get around the natural tendency to invest when markets are very high and so is optimism, but hold back when the news is bad.
“Actually, weak markets are a good time for long-term investors to put money in, even though our emotions tell us otherwise.”
When investing, it is important to think about the potential tax implications. If your portfolio does not sit inside a pension or an Isa, you will be liable for capital gains tax (CGT) on any profits you eventually make. In the 2015/16 financial year, the annual CGT allowance is £11,100 per person, so only any gains above this level are taxable.
The CGT rate at present is 18% for basic-rate taxpayers and 28% for higher- and additional-rate taxpayers.
Potential CGT bills can be minimised by taking money out of your portfolio gradually to try to keep any realised profits below the annual limit.
If your investments are held in a stocks and shares Isa, they are exempt from CGT. In 2015/16, the annual Isa limit is £15,240 – this is the maximum amount you can put in an Isa before 6 April 2016.
With a pension, on the other hand, any income or withdrawal you take from it is taxable at your marginal rate once you’ve taken 25% tax-free. But there are tax advantages when you put money into the pension, Hollands says.
“A pension has particular attractions for long-term investors, as the state adds to any investment you make, so that every £80 contributed is ‘grossed up’ to £100 – and there can be further tax savings if you pay tax at the higher rates,” he explains.
“But money in a pension is tied up – currently the earliest date you can access it is 55, but that is expected to rise – so
many people prefer to invest in Isas.
“There’s no state top-up with an Isa, so the tax perks are not as attractive, but the returns are tax-free and they are very flexible, as you can withdraw your investment at any time”.
When it comes to investing, buying stockmarket-listed company shares – or funds made up of them – isn’t the only game in town. Alternative investments such as buy-to-let property and crowdfunding have been the subject of growing levels of interest recently.
Landlords across the UK have been enjoying healthy returns over the past few years as property prices and rents have resumed their upward trend.
Meanwhile, online equity crowdfunding platforms have made it much simpler for individuals to buy shares in new, potentially fast-growing businesses that are as yet not listed on any stockmarket.
According to Heather Ferguson, an investment analyst at Hargreaves Lansdown, a potential problem with alternatives such as these is the lack of diversification they offer.
“The important point to remember is an investment fund will be diversified over a number of different companies and sectors whereas alternative investments can be heavily concentrated in one area,” she says.
Ferguson points out that once mortgage costs, stamp duty, maintenance, agency fees and void periods are considered, returns from property could be significantly lower than expected.
“Property appeals to many investors as it is a physical entity, which is relatively simple to understand. However, many overlook the costs involved in such an investment and therefore overestimate the income potential.
“In addition, buy to let isn’t a very tax-efficient investment. It can’t be held in a Sipp [self-invested private pension] or Isa and the government is also restricting tax relief on mortgage interest to just basic rate.”
This restriction will be introduced on a gradual basis from 2017.
As far as crowdfunding is concerned, Ferguson points out that a typical cautious investor would usually put money into one or more large, well-established companies rather than the very small firms, which typically seek equity crowdfunding and are generally regarded as higher risk.
“Crowdfunding is not as highly regulated as investment funds or larger individual companies and there is a high risk of losing the capital invested,” she adds.
Evaluate your portfolio
Once your investments are up and running, it is important to keep tabs on them, not just to see what kind of returns you are making but also to ensure they remain appropriate, given your attitude to risk and your overall aims.
Philippa Gee, manager director at Philippa Gee Wealth Management, says there are tools available online – for example, on the platforms where investors can buy and sell funds – where you can input details of your portfolio and review its performance.
“Be realistic, though: your investment might not have performed well over a particular period, but that could be for a good reason that no longer applies,” Gee says. “So while the raw data can help, you need to drill down and understand what you are invested in and why.”
If you are trying to work out whether your portfolio is doing well or not, there is no point comparing apples with oranges. “It all depends on what you are trying to achieve,” Gee explains.
“If you are looking for minimal risk and would prefer small but certain gains, then judging your returns against the FTSE 100 is the wrong approach. Decide what benchmark you want to use for risk and for return and then use that to interpret the data.
“If you have chosen a fund that is not performing well even when the sector it is in does well, this is a good indication that everything is not as it should be.
“Equally, you might need to change tack if you are in an expensive fund, which is not delivering value for money or when the fund manager moves on or retires. Nothing in the investment world stays the same, so keep monitoring.”
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.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
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.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
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.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
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.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.