What should I invest in?
As each has its own characteristics, picking the one – or even two or three – that's right for you could bring additional benefits to your investment strategy.
If you invest directly in shares you are holding a small part of a company and will benefit financially if it is successful, either through an increase in the share price or through dividends, where the company distributes the profits it doesn't reinvest in the business.
Shares are bought through a stockbroker or an online sharedealing service and you'll pay a charge of around £10 plus stamp duty reserve tax of 0.5% of your investment. However, shares listed on the Alternative Investment Market (Aim) are free of stamp duty from 6 April 2014.
- You can choose which companies you want to invest in
- As a shareholder you usually have the opportunity to vote on some company decisions
- Lack of diversity - unless you hold a portfolio of shares your investment is concentrated in one company
- Dealing charges can make this an expensive way to invest if you are a small investor
Funds such as unit trusts and open-ended investment companies (Oeics) are collective investments which allow investors to pool their money together to create a large fund that invests across a range of different shares and/or other assets such as bonds. This is run by a professional manager in line with the fund's objectives.
Not all funds are actively managed: some are run on a passive basis with a computer programme replicating the holdings of an index such as the FTSE 100 or the FTSE All-Share. This means the performance of the fund will never beat the return of the index, although this isn't necessarily something that an actively managed fund will do either.
To invest, you buy units with minimum investments as low as £500 or £25 a month, and there are no restrictions on when you sell. Charges vary depending on the type of fund and how you buy it but are typically an initial charge of up to 5% and an annual management charge of up to 1.5%. Most online discount brokers will refund all of the initial charge and many refund a portion of the AMC.
- Instant diversification without a large upfront investment by you
- Investment decisions are taken by an experienced professional manager
- Thousands of different funds to choose from investing in equities, bonds and property as well as other types of assets
- Management charges can be high
A pension fund is operated in exactly the same way as a fund, with a manager investing according to the fund's objectives, but because it is a wrapper specifically for pension investments, there are some important tax advantages.
Subject to your earnings and the annual and lifetime pension limits, anything paid into a pension fund receives tax relief at the basic rate, effectively topping up an £80 contribution to £100. Higher rate taxpayers receive tax relief at their highest marginal rate. Additionally, although you cannot reclaim the 10% tax credit on dividends, all income and gains are also tax-free.
However when you come to take benefits, either as an annuity or when drawing income from a personal pension, these are subject to income tax.
- Instant diversification
- Tax breaks
- Money cannot be accessed until retirement
EXCHANGE TRADED FUNDS
Another form of collective investment, exchanged traded funds (ETFs) seek to replicate the performance of an index, commodity or basket or assets. This tracking is achieved either by holding the constituents of the index or by using derivatives to create it synthetically.
ETFs are a branch of 'exchange traded products', which also encompass exchange traded commodities (ETCs) and exchange traded notes (ETNs)
Other ETFs also seek to follow thematic investment indices, such as those that comply with Shariah law or socially responsible principles, or which appeal to income-seekers, for example.
ETFs are traded on the stock market, so there are upfront dealing charges to consider although they are exempt from stamp duty reserve tax. The annual management charge is very low with many ETFs having an annual total expense ratio of less than 0.5%.
- Low cost
- Access to more exotic markets as well as the well-known indices
- Instant diversification
- Counterparty risk on synthetic ETFs
VENTURE CAPITAL TRUSTS
A venture capital trust (VCT) is a form of investment trust that invests in fledgling companies that are looking to develop their business. The nature of these companies means that this is a higher risk investment: while some will turn into the large corporations of tomorrow, others will inevitably fail.
As a result there are a number of tax incentives to encourage investment. These include tax-free income, dividends and gains and an income tax rebate of 30% of your initial investment into new VCT shares, providing you have paid sufficient income tax that year and you hold the shares for at least five years.
The maximum investment to obtain tax relief is £200,000 a year but, due to the high level of risk, it is recommended that VCTs only form a small part of your total investment portfolio.
- Generous tax breaks
- Opportunity to invest in very small companies
- High risk and therefore more suited to sophisticated investors
This feature was writtten for our siser publication Money Observer
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.
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).
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Total expense ratio
Most investment funds levy an initial charge for buying the units/shares and an annual management fee but other expenses also occur in running the fund (trading fees, legal fees, auditor fees, stamp duty and other operational expenses) which are passed on to the investor and so the TER gives a more accurate measure of the total costs of investing. The TER is especially relevant for funds of funds that have several layers of charges. Unfortunately, investment fund companies are not obliged to reveal TERs and many only publish the initial charges and annual management charge (AMC).
Venture Capital Trusts were introduced in 1995 to encourage private investments in the small-company sector by offering tax relief in return for a minimum investment commitment of five years. A VCT is a company, run by a fund manager, which invests in other companies with assets of no more than £7m that are unlisted (not quoted on a recognised stock exchange) but may be listed on the Alternative Investment Market (AIM) or plus with the aim of growing the companies and selling them or launching them on the stock market. Investors in new VCTs are offered desirable tax advantages and VCTs themselves are listed on the London Stock Exchange, with strict limits laid down by HM Revenue and Customs on what they can invest in and how much they can invest.
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.
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.
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%.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
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).
Alternative Investment Market
AIM is the London Stock Exchange’s international market for smaller companies. Since its launch in 1995, 2,200 companies have raised almost £24 billion listing on AIM. The market has a more flexible regulatory system than the main market and can offer tax advantages to investors but its constituents are a riskier investment than bigger companies listed on the main market.