What you could do with £20,000
What would you do with a £20,000 windfall? Pay off a chunk of your mortgage? Buy a flash car? Or tuck it away for a rainy day? There is no end to the possibilities, but what would be the best option for you in the current economic climate?
We have drawn up three fictional case studies - each with very different circumstances and priorities - and asked some leading independent financial advisers what they would recommend for each person, based on their individual goals, attitude to risk and capacity for potential loss.
CASE STUDY ONE: TONY - A SINGLE MAN IN HIS LATE 20s
Young and carefree, accountant Tony is enjoying the trappings of success. He has made light work of climbing the career ladder and lives in a rented flat in South London, drives a company car and enjoys a good lifestyle.
As a higher-rate taxpayer, he manages to clear his debts each month and has also managed to accrue £40,000 of savings. He'd like to get onto the property ladder but also wants to dip his toes into the investment sea. He's a risk taker by nature. He's also happy to lock his money away for the longer term in the hope that he will enjoy bumper returns in the future.
As Tony wants to get on the property ladder, he could combine his savings with £10,000 of his windfall to put together a deposit - £40,000 would be enough for a 20% deposit on a £200,000 property, which is roughly what he'd have to pay for a one-bedroom flat on the outskirts of London.
He'll also have another £10,000 to play with to pay for stamp duty, solicitor's fees and other costs, including new furniture.
For the £10,000 that's left, he should put £5,000 aside in a savings account as a rainy-day pot. However, being a higher-rate taxpayer who isn't in immediate need for money, he could also start thinking about investing - and he could use the last £5,000 for that.
He should consider investing into an ISA, recommends Neil Mumford, chartered financial planner at Milestone Wealth Management. Based on his risk profile, Mumford suggests dividing the money between four funds.
"I'd put 40% into the Trojan fund as this would be the core stable low-risk part of the portfolio," he says. "The remaining 60% I would split equally between three investment trusts: Murray International, Aberdeen Asian Income and Invesco Income & Growth. These are equity-based income-producing trusts but have the potential for capital growth as well. The overall portfolio gives good global diversification.
"The long-term benefit of these investment trusts is that some of the income yield is held back in reserve and, as a result, they all have long track records of paying increased dividends year on year," Mumford adds.
The idea of having these investments is that the income could be re-invested, which always makes sense over the longer term.
CASE STUDY TWO: ANDREW AND MEGAN - A MARRIED COUPLE IN THEIR EARLY 40S WITH TWO CHILDREN
Andrew and Megan have been married for eight years and have two young children - Mark, 6, and Natasha, 2. Andrew works as a supermarket manager, while Megan is a part-time teaching assistant.
They live in a three-bedroom semi-detached house in Bristol and have a mortgage. They have no outstanding debts and a few thousand pounds in a cash ISA. They want to enjoy some of the windfall because they haven't a lot of spare cash in recent years. They describe themselves as relatively cautious and keen to make their money work hard.
The couple should consider repaying at least part of their mortgage, according to Dennis Hall, founder of Yellowtail Financial Planning. "With a mortgage rate of 5%, they would need an investment to be producing around 6% after tax just to match what they could save on the mortgage," he points out.
As they can make overpayments on their existing mortgage arrangemet, they could pay off £5,000 - this would help reduce their current outgoings and the longer-term costs of their house. As the couple will also need a new car soon and haven't been on holiday since the children were born, a further £5,000 could be set aside in an instant-access cash ISA for these purposes.
As they already have a rainy day pot, the remaining £10,000 could be earmarked for the longer term, suggests Hall. "Putting the money in a stocks and shares ISA would give it the potential to grow," he says.
Considering the couple's unwillingness to take much risk, Hall recommends using a multi-asset class fund such as Cazenove Diversity. "It's relatively low risk with investments spread across different markets," he says. "It means they will be giving up some of the growth that equity markets can deliver in the good times, but will be better protected if the markets turn sour."
CASE STUDY THREE: SUSAN - A WIDOW IN HER 50S
Susan was widowed last year and her husband's life insurance policy was enough to pay off the mortgage on her £350,000 detached three-bedroom bungalow in Cheshire. Although she doesn't have a great deal in the way of rainyday savings, the only outstanding debt she has is £2,000 on a credit card.
Describing herself as relatively cautious when it comes to investing, she doesn't want to take unnecessary risks with her money. She is also keen to set some money aside for her young granddaughters.
The first step is to pay off the credit card to save the monthly interest and then to think about putting some cash reserves aside for emergencies, according to Carl Melvin, managing director of Affluent Financial Planning. "I'd recommend Susan puts £5,000 into an instant-access cash ISA as this would provide a tax-free, readily available fund."
With the remaining £13,000, she should consider the need for any big expenditure. For example, will her car need replacing? Are there urgent house repairs that will need doing in the near future? "This is the perfect opportunity to set money aside for such costs. Let's budget for £2,000 to go into this pot, which can be held in an instant-access savings account for now," he says.
If she wants to help her grandchildren – and bearing in mind that being a homeowner with savings means she might face inheritance tax issues in the future – the obvious solution will be to use the tax rules that allow her to make an annual gift of £3,000. "Presuming she hasn't used last year's allowance, she can carry this forward, which will enable her to gift £6,000 this year – split equally between her granddaughters."
The remaining money – £5,000 – can be invested in a stocks and shares ISA for her future. She's still relatively young so could feasibly live another 40 years, which means it's not a good idea to put every penny into cash because of the long-term eroding effect of inflation,
according to Melvin.
"It can be invested in a cautious way with a bias towards fixed interest, although I believe even that kind of approach needs to have an element of equity exposure in order to drive long-term growth," he says. "I'd suggest she considers a tracker fund such as those available from Vanguard or HSBC."
An unexpected one-off financial gain in cash or shares, generally when mutual building societies convert to stock market-quoted banks. Also windfall tax, a one-off tax imposed by government. The UK government applied such a measure in the Budget of July 1997 on the profits of privatised utilities companies.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
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.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
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).
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.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).