Make the most of ISA allowances while you still can
This year looks set to be characterised by a lot of head-scratching by the government about how to dig us out of the enormous multi-billion pound crater that is the public debt.
With this head-scratching comes immense uncertainty over which tax incentives will remain and which tax rates will be pushed up to revitalise the Treasury's finances.
Income tax, national insurance and pensions have not been immune from the chancellor's tinkering, while child trust funds have been the subject of much debate.
Individual savings accounts (ISAs) may also come under threat from this government or the next as they are forced to make drastic cuts to reduce our ballooning deficit.
"A possible change in government this year and pressure on the public purse could put ISA allowances in jeopardy in future years," says Sheridan Admans, investment adviser at The Share Centre. Therefore, it is essential that investors make the most of their ISA allowance now.
Another reason to fund your stocks and shares ISA and review your investments is that cash is still a dud performer. The base rate is 0.5% and many economists believe rates won't rise over the next six months, and maybe not at all this year.
With this in mind, investors should strive to use their full allowance before 5 April in case the government's belt-tightening leads to a cut in the allowance in future years or even a cull of the tax wrapper altogether.
Time for a check-up
Chucking your £7,200 (or £10,200 if you're over 50) into an ISA product is just the start though. Where is your money actually going? When did you last review your ISA?
Financial advisers recommend a thorough check-up at least once a year, although if your ISA contains shares it should be done much more frequently. Checking your ISA quarterly is good practice.
A stocks and shares ISA is a long-term vehicle, and it is recommended that funds are held for at least three years to measure true performance.
This means you shouldn't go crazy every year and construct an entirely new portfolio for the sake of it. But some light spring cleaning is a must, especially when markets are turbulent.
Your ISA holding choices will depend on your goals and how much risk you're prepared to take. If you are a cautious investor, bond funds have merits, although they probably won't hit the starry heights of 2009 anytime soon.
"Strategic bond funds such as M&G Optimal Income or L&G Dynamic Bond could be ideal for cautious investors this year," explains Admans.
"Strategic bond fund managers try to capitalise on the most economic scenarios, giving investors exposure to a broad array of fixed-interest securities, which helps maintain diversity in a well-rounded portfolio."
Nick McBreen, independent financial adviser at Worldwide Financial Planning, recommends the following funds for cautious investors: Aegon Global Bond, Fidelity Moneybuilder Income, Invesco Perpetual Global Bond and Close UK Escalator 100.
Bond investors should watch out for signs of inflation that could prompt the Bank of England to raise interest rates. A rise in rates and inflation would knock fixed-interest investments.
According to Dennis Hall, founder of Yellowtail Financial Planning, the one fixed-interest sector that would work well in this scenario is index-linked.
"Here, the charges are a big factor and a tracker fund may be the answer. Legal & General has an All Stocks index-linked Gilt Index Trust in both accumulation and distribution units," he says.
However, if you think the bond boat has well and truly sailed and are after something a bit different, Stephen Peters, investment trust analyst at Charles Stanley, suggests investment vehicles that focus on absolute return and infrastructure.
He recommends four absolute return funds: Insight Absolute UK Equity Market Neutral, BlackRock European Absolute Alpha, Gartmore UK Absolute Return and Schroder Emerging Market Debt Absolute Return.
Investing in infrastructure may come back into fashion as the government looks creatively at its balance sheet. This could give privatisation a new lease of life, for example, for hospitals and motorways.
Peters rates three investment trusts: International Public Partnerships, HSBC Infrastructure and 3i Infrastructure.
If you have a long-term investment horizon and are happy to take more risk, many more ISA options are open to you.
As the UK grapples with its deep recession and political uncertainty with the spring heralding a general election, financial advisers agree that adventurous investors should avoid the UK and go global instead.
Adrian Lowcock, senior investment adviser at Bestinvest, is keen to plug Japan. "Japan looks interesting: at present, it trades on a 40-year low on a price-to-book basis. Japan has typically been a poorly performing market, but once in a while it delivers.
With its strong manufacturing base and easy access to Asia Pacific markets, Japan is a cheaper way of tapping into that story." He recommends the Dublin-registered JO Hambro CM Japan Retail fund.
Advisers concur that emerging markets (chiefly China, India and Brazil) will continue to flourish. BlackRock Latin America, an investment trust, and the Ignis HEXAM Global Emerging Markets fund are recommended by Peters.
Admans suggests First State Asia Pacific Leaders and Allianz BRIC Stars. "Given the anticipated lower growth opportunities in Western markets, higher-risk investors might do well to consider Asia Pacific and emerging markets," he notes.
Admans is particularly enthusiastic about India: "Over recent years, we have seen India become more open to overseas investment thanks to major financial reform. It is also experiencing an increase in domestic consumption.
As such, investors could consider the First State Indian Subcontinent fund, which benefits from its managers and analysts being involved with Indian markets on a daily basis."
Investors shouldn't be afraid to look at country-specific funds rather than just generic emerging markets funds. "The risk certainly increases, but so can the returns," Hall declares.
As Brazil leads the way in Latin America, rather than buying a Latin America fund investors should consider buying a specific product such as the iShares MSCI Brazil exchange traded fund (ETF), Hall reasons.
In terms of sectors, Hall and McBreen believe oil and gas could be worth a look. McBreen says it continues to make a compelling case, although smart investors should also look at alternative energy investments.
Hall dishes out a share tip: "For a complete off-the-wall punt, you may want to bet on the discovery of oil around the Falkland Islands.
A company called Falkland Oil and Gas has recently raised money to hire a drilling rig to take its research to the next stage. If it finds lots of oil, the shares could rocket."
Private equity has had a rollercoaster ride, but advisers believe the tide is turning. Peters says a private equity fund, such as Electra Private Equity, which has a good portfolio and no excessive over-commitments in other funds, could give a tired ISA a boost this year.
In addition to making sure your ISA is poised to outperform, you should look at the portfolio in the context of your other investments.
Although financial advisers usually recommend diversification, your ISA pot does not necessarily need to be diversified if it sits alongside a non-ISA portfolio.
"The tax treatment of the ISA means it may be more beneficial to hold the fixed-interest portion of your portfolio in the ISA to maximise the tax advantages, particularly if the investor makes minimal taxable capital gains," comments Hall.
As we all have an annual £10,100 capital gains tax (CGT) allowance, if you don't have room for both your income tax generating investments (such as corporate bonds) and your CGT-generating investments in your Isa, you should put the former in.
You'll save between 20% and 50% in tax (depending on how much you earn), rather than 18%.
If your ISA is your sole investment pot, it should be diversified. Your choice of holdings will depend on your attitude to risk, but having a mix of fixed income, equities, cash, property and commodities is a good start.
As part of your ISA spring cleaning, you should be prepared to switch out of a fund that has been consistently in the doldrums and shows no signs of recovery. Or perhaps your fund gained a new manager a few years ago and performance has nosedived ever since.
Switching between funds if you're in a fund supermarket is normally a straightforward online process. Switching your ISA provider is a slower process that can take weeks or months to complete.
During this time you will be unable to deal. There may also be exit penalties. Changing provider is therefore not a decision to be taken lightly.
If you're still unsure about where to put this year's tax allowance, you can always "park" in cash. But this should only be for the short term, as you will incur a 20% tax charge on the interest until you reinvest.
Let's hope these useful vehicles, which can help get future generations interested in saving and investing, and supplement a pension as UK pension provision becomes ever more stingy, are safe from Alastair Darling's (or George Osborne's) clutches.
The quest for income
Investors struggling to find income have reason to cheer this year, as those much-talked-about green shoots of recovery should be accompanied by dividend increases sprouting around the world.
Peters believes UK companies will start to beef up their dividends following cuts last year and that Asian income funds might also perform well. He names GlaxoSmithKline and National Grid as decent dividend distributors this year.
"GSK yields 5.3%, while National Grid yields 5.9% [at current prices]," notes Peters.
Lowcock is also bullish on equity income. He says the yields are attractive and the sector will become popular again this year.
McBreen cautions that any good news in the UK will come in the second half of the year though, as uncertainty will prevail until the general election.
Therefore, income-seekers should spread their wings and consider more politically stable countries. "Global markets represent excellent openings for investors and the emerging markets story is not over by a long mile," says McBreen.
"Income-seeking investors have to bite the bullet and really confront their demons: the need for a higher yield than they can get from cash deposits requires a major review of investment risk to determine where they should be investing for income."
He boldly adds: "The old model of dependence upon fixed interest securities is a thing of the past. Future income streams will come from dividend yield."
Income funds recommended by financial advisers as worth putting in your ISA include Rensburg UK Equity Income, Investec Monthly High Income, Threadneedle High Yield Bond, Neptune Income, Invesco Perpetual Monthly Income Plus and the Perpetual Income & Growth investment trust.
Lowcock says property is also worth a look. "Commercial property is an income investment by nature, and with yields now looking attractive compared with other asset classes, we have already started to see some movement of valuations off the bottom. New Star UK Property looks good."
He also recommends ING UK Real Estate Income investment trust, as it mainly focuses on providing returns through higher-yielding assets.
Peters has two more investments trusts for income hunters: International Public Partnerships which he points out is "offshore, so pays a gross dividend of 5%" and Edinburgh, a UK equities trust run by Neil Woodford, which he expects to see outperform because of its holdings in undervalued defensive stocks, and "paying out its quarterly 6% dividend yield as well".
Will recovery funds shine this year?
Recovery funds performed strongly last year as many firms fought the recession by cutting costs and reshuffling their management, which meant they eventually rebounded robustly.
In the same way that bonds are unlikely to repeat their 2009 success this year, recovery funds may not shine quite as brightly as last year, because the recovery has already occurred in many investors' eyes.
However, we are officially still in a recession and unloved and undervalued companies are still knocking around.
The M&G Recovery fund, which celebrated its 40th birthday last year, is one of the strongest and most experienced in the field.
"It's very hard to argue with a 40-year track record of delivering what it says on the tin,' says Hall. "The management team [led by Tom Dobell] aren't 'fresh-out-of-the-box' graduates, and the fund has witnessed tough times before and come through.
They are prepared to take big stakes in companies and have an active role in assisting the management to turn around their companies."
According to McBreen, special situations funds should perform well this year. It's hard to pinpoint the difference between special situations funds and recovery funds because it depends on the sector they sit in and what the fund manager's strategy is.
Therefore, it's important investors look carefully at the fund's investment strategy to make sure it fits in with their portfolio.
McBreen recommends CF Miton Special Situations and BlackRock Special Situations. Admans likes Investec UK Special Situations, which he says is suitable for investors looking for additional UK exposure to complement a mainstream blue chip UK equity fund.
Over the past year, the fund has returned an impressive 38%, putting it in the top quartile.
This article was originally published in Money Observer - Moneywise's sister publication - in February 2010
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.
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 scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
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.
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.
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%.
The managers of these funds look for shares in companies that have fallen in price and popularity for reasons such as operational difficulties, management changes or financial over-extension, are unloved by the market but have the potential to recover over the long term. Managers of recovery funds focus on buying these undervalued companies where they see significant potential that should lead to a turnaround in their fortunes, a renewed appreciation by the market and that recovery will be reflected in the share price.
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).
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.
An Exchange traded fund is a security that tracks an index or commodity but is traded in the same way as a share on an exchange. ETFs allow investors the convenience of purchasing a broad basket of securities in a single transaction, essentially offering the convenience of a stock with the diversification offered by a pooled fund, such as a unit trust. Investors buying an ETF are basically investing in the performance of an underlying bundle of securities, usually those representing a particular index or sector. They have no front or back-end fees but, because they trade as shares, each ETF purchase will be charged a brokerage commission.
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.
An acronym, which stands for Brazil, Russia, India and China; countries all deemed to be at a similar stage of advanced economic development. The term was coined in 2001 in a report written by Goldman Sachs director Jim O’Neill who speculated that, by 2050, these four economies would be wealthier than most of the current major G7 economic powers.
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.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
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.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Absolute return funds
Absolute return funds aim to deliver a positive (or ‘absolute’) return every year regardless of what happens in the stockmarket. Unlike traditional funds, they can take bets on shares falling, as well as rising. This is not to say they can’t fall in value; they do. However, over the years, they should have less volatile performance than traditional funds.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
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).
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
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.