Make tax-free gains from your punt on the markets
This year, a combination of two forces is making the use of spread betting and contracts for difference (CFDs) increasinly enticing.
Firstly, markets are set to be more volatile and yet see very little growth, so the fact that both of these instruments enable you to make money from volatility itself makes them particularly appealing.
Secondly, with people earning more than £150,000 a year being hit with a 50% tax on income (from 6 April this year) these tax-free options well worth considering.
What is spread betting?
Spread betting is essentially a form of gambling. Unlike buying shares or stocks, you are betting on which way market or share price values will go.
The 'spread' is the gap between a higher 'buy' price and a lower 'sell' price. You can 'go long' by betting that the market will perform better than the top end of the spread, or you can 'go short' by betting it will do worse than the bottom end.
You don¹t put on a fixed stake. Instead, you bet a specific amount per point.
Say, for example, an index was at 5550, and the spread available was 5545-5555. You may be confident it will rise, so you might put an 'up' bet on, for £10 a point. If it then rose to 5605, you would earn £10 times 50 points, which in this case equals £500.
In effect, the more correct your judgement, the more you'll win. But on the flip side, if the bet goes against you, the more you stand to lose.
Most providers will allow you to set a stop-loss, which means after you hit a particular level of losses, your position will be cashed out, to avoid you running up debts you cannot afford.
What are CFDs?
CFDs work slightly differently. With these, two parties agree to exchange the difference between the current price and a price at some point in the future.
You can be a 'seller', who will make money if the value falls between now and your chosen time in the future. Alternatively, you can be the 'buyer', and benefit if the price rises.
With both spread betting and CFDs, in order to place a bet you have to hand over a deposit of between 5% and 25% (usually 10%) of the underlying value of the deal.
The deposit is based on the margin requirement, which varies according to the asset you're betting on. The bigger the risk, the bigger the margin requirement tends to be.
The ability to bet on margin has the advantage that you don't need all the cash to hand in order to take a big position.
Assuming you wanted to spread bet on the share price of a blue chip with a margin of 10%, you could put down just £100 in order to take a position on £1,000 worth of shares.
The other big attraction is that gains aren't subject to income tax. Phil Seaton, partner of LS Trader, says: "A major factor is the tax-free advantage that is currently in place for financial spread betting in the UK.
"People with higher incomes who have substantial investments will not be too keen to pay the new higher level of income tax at 50%, which came into effect in April this year.
"One way of getting a better return on investments is not to pay any tax on your profits, which can be done in the UK with financial betting."
And because this is classed as gambling, any gains from spread betting are also free from capital gains tax, making them still more attractive. You won¹t have to pay stamp duty with CFDs or spread betting because you don't own anything.
The costs are low too. For CFDs there is a small commission to pay, usually between 0.1% and 0.25%; for spread betting there is normally no commission.
If a position moves against you and you don¹t have enough of a deposit, you will be asked to put up more. You also need to consider the interest on any long position.
Most brokers only charge LIBOR (which is around 0.7% at the moment) plus 2.5%. However, if you leave a position open for a long time waiting for a bet to go in your favour you can find the costs mount up.
The two instruments have much in common, and are both popular with day traders, who can make or lose considerable sums from small price movements. However, they can also be used to protect a position you may have elsewhere.
So, for example, if you had a large holding of a particular share in your portfolio and were worried that the price might fall, you could hedge by going short on the stock, so that any losses on the stockholding would be offset by gains on the spread bet.
These are sophisticated instruments, and can be dangerous for the unwary, so the experts recommend you try a dry run before you take the plunge.
One way to do this is through the dummy accounts offered by some of the providers, which allow you to try your hand at spread betting and get an idea of the potential gains and losses, without the pain of losing your money.
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.
Allows you to bet, or take a position, on whatever you think a financial market will do next. The more the market moves in your favour (up or down), the more you profit, with unlimited potential. Similarly with losses, if the market moves against you. A spread betting company will offer a quoted “spread” on an index, share or even elements of a sporting fixture. If you think a market is set to rise, you ‘buy’ at the top end of the quote (the offer price), or if you think the market will fall you ‘sell’ at the bottom of the quote (the bid price). All gains are tax-free but you will have to deposit money with the spread betting company to cover any losses and if your losses exceed that, the company will demand more money to cover your loss-making position. Spread betting is risky; it’s for people who know what they’re doing rather than for novices.
The London Inter-Bank Offer Rate is the rate at which banks lend to each other over the short term from overnight to five years. The LIBOR market enables banks to cover temporary shortages of capital by borrowing from banks with surpluses and vice versa and reduces the need for each bank to hold large quantities of liquid assets (cash), enabling it to release funds for more profitable lending. LIBOR rates are used to determine interest rates on many types of loan and credit products such as credit cards, adjustable rate mortgages and business loans.
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.
Named after a high value gambling chip, the term is used for an investment seen as solid and whose share price is not volatile. Blue chip companies are normally household names and have consistent records of growth, dividend payments, stable management and substantial assets and are the bedrock of a pension fund’s portfolio.