Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Inspiration for your ISA
Do you need some inspiration for stocks or funds to put in your ISA? We’re here to help, whether you are new investing, a bit rusty on what to do, or are even highly experienced at putting your money to work in the markets.
With the end of the tax year just around the corner, it’s certainly a good time to think about making the most of ISAs.
If you haven’t invested the whole £15,240 ISA allowance for the 2015/16 tax year you might want to consider topping up your pot. This will ensure you make full use of the tax breaks available. Any money you put into an ISA is free of income tax and capital gains tax (CGT).
Don't miss out
Any unused allowance doesn’t roll over into the new tax year. For example, if you’ve only invested £5,240 by the end of 5 April this year in your ISA, you can’t add the remaining £10,000 unused portion to the amount of money permitted in an ISA once you get into the new tax year.
The annual allowance is increasing to £20,000 from 6 April this year. You can spread the allowance across the whole range of ISAs, including Cash ISA, Stocks and Shares ISA, the Innovative Finance ISA and the new Lifetime ISA.
Help from the experts
Whether you’re relatively new to investing or have years of experience, it can be difficult to decide which assets to add to your investment portfolio.
To help you, we’ve spoken to a number of experts to get the lowdown on what strategy might be suitable for a range of different people and which stocks and funds could help you reach certain goals.
This week we discuss investments for three types of individuals: the beginner, the forward thinker, and the undecided.
Keep your eyes peeled for another three scenarios in next week’s issue of Shares which comes out on Thursday 30 March 2017.
Setting up a diversified portfolio is an important first step when you start investing because it ensures you spread risk, rather than putting all your eggs in one basket.
You can build a balanced portfolio by selecting a range of asset classes, such as bonds, stocks, property, commodities and cash. The balance between these assets will depend on your personal investment strategy, target returns, time horizon and appetite for risk.
Justin Urquhart Stewart, director at investment manager 7IM, says investors should only think about equities for a longer-term horizon like retirement saving.
Although younger investors have time on their side, Urquhart Stewart says many have had their fingers burned and made the expensive mistake of avoiding shares for the rest of their lives.
‘You’ve got a few stocks and hopefully they’ve done well and you’ve enjoyed watching their performance. But being serious about investing doesn’t mean just buying stocks.
‘In fact, if you’ve not got a lot of money, you can easily find that the transaction costs of buying individual stocks are a big drag on performance – especially if you make the common mistake of overtrading. The first step towards disciplined investing is disciplined saving,’ he says.
A simple way to build a balanced portfolio is to buy a multi-asset fund, which invests in a combination of asset classes, such as cash, equities and bonds.
‘This gives you easy access to one professionally managed fund that invests in a broad range of equities, as well as bonds and other assets, so you get the benefits of diversification and expert fund management in a cost-effective package,’ says Urquhart Stewart.
He suggests beginner investors start with a low risk multi-asset fund and then build up so they get comfortable with the way markets operate.
WHAT ARE MULTI-ASSET FUNDS?
Multi-asset funds are risk-rated so you can find one which suits your individual risk profile. Henderson, for example, has four multi-asset funds which have been assigned risk profiles of 3, 4, 5 and 6 by Distribution Technology, a risk-profiling company.
Henderson Core 3 Income Fund (GB00B8289886) is considered low risk. It has a 37% exposure to bonds, 26% exposure to cash and 20% exposure to equities.
Holdings include direct property fund Henderson UK Property (GB00BP46GN32); RWC Enhanced Income (LU0539372689), which invests in UK and US large-cap stocks; and ETFS Physical Gold (PHAU), a gold exchange-traded fund.
Henderson Core 6 Income & Growth Fund (GB00B96RS580) is considered to be high-medium risk. It has a 59% exposure to equities, 16% exposure to bonds and 10% exposure to cash.
Holdings include iShares UK Dividend ETF (IUKD), JP Morgan Global Emerging Markets Income Trust (JEMI) and Henderson Asian Dividend Income (GB0003243465).
Funds vs Shares
A single fund can provide greater diversification than buying single stocks. This is because funds can own hundreds of individual stocks and/or bonds.
Russ Mould, investment director at AJ Bell Youinvest, says you can spread risk across different geographies using global funds or collectives that target more than one region.
‘You should certainly think twice about parking all of your money in the UK simply because you know it best, as such behavioural biases can mean you miss out on better returns elsewhere,’ he says.
Mould reckons buying individual stocks is too bold a step for beginners because you need to conduct thorough research and have specialist knowledge.
However, he suggests a good way to start is to look at the top 10 holdings of a top-performing fund and watch how they do before putting your capital at risk by buying individual company shares.
What to buy first?
If you are like Alexa and can only afford to buy investments every other month it can be difficult to decide what to buy first. Although much will depend on your personal investment strategy, the prevailing market conditions will be a big factor.
Mould says if stock markets have just collapsed and bond markets have surged that may present an opportunity to glean exposure to shares, directly or via a fund, at attractive valuation levels.
‘That said, trying to time the market is a fearsome task and whether you target stocks, bonds or property first will depend on the returns you are seeking, the time period you have available and how able you are to withstand some losses along the way,’ he explains.
A lot of people underestimate how much money they will need for their retirement and often start saving late in life.
Family spending data produced by the Office for National Statistics suggests the average pensioner would need £215 a week just to cover basic costs like food, clothes, travel and heating, equating to £11,000 a year.
Many investors would find the idea of merely covering the basics unappealing – you probably have some ideas or dreams about how you envisage your retirement.
According to Saga Investment Services, Brits over age 50 need double the amount of pension for which they’ve budgeted in order to generate a decent income in retirement.
Why an ISA can help
An ISA can be a good way of backing up pension savings in retirement. This is particularly the case if you’ve already used up your pension allowances. The lifetime allowance for pensions is £1 million and the annual allowance is £40,000, but this reduces for higher earners.
‘The lifetime allowance can pose a problem for individuals with large pension pots. Unless there are significant changes by the time an individual draws benefits, there are penal tax charges for exceeding this (up to 55% tax on any excess). For these individuals, an ISA can be an attractive vehicle for additional savings,’ explains Carl Lamb, managing director at Almary Green Investments.
There are lots of other reasons why focusing on building an ISA pot is a good idea for people with a large pension. Charles Calkin, a financial planner at James Hambro & Co, says if all your retirement income comes from a pension you may find yourself paying a fair bit of income tax.
‘If you can limit how much you draw on your pension and complement this by drawing down on your ISAs too – money that is free of income tax and capital gains tax – then you can really bring your income tax bill down and make sure your savings are working efficiently for you.
‘This is also a good way of managing inheritance tax liabilities because pensions are now a smart vehicle for cascading wealth down the generations tax-efficiently on death. Many people now choose to draw more heavily on ISAs in the first part of their retirement and then on their pensions last,’ says Calkin.
What should someone like Nigel do?
Calkin suggests someone like Nigel should consider sharing assets with his spouse, using both ISA allowances to save and using both personal allowances when taking income.
If you are like Nigel and have 10 years until retirement, choosing investments for your ISA will depend on your attitude to risk and the goals for your ISA and pension pot.
James Horniman, a partner at investment manager James Hambro & Partners, says if your pension is edging close to the £1 million lifetime allowance, you might want to reduce the investment risk – and therefore growth potential – of your pension.
You could then take enhanced risk with your ISAs. There are limits on how much you can put into an ISA each year but no limits on how much they can grow.
‘It’s worth trying to work out your attitude to risk and that of any partner. Couples all view and manage their money differently. If you see your savings as one pot, then find an approach to investment risk that you’re both comfortable with and try to make sure that, on balance, your overall portfolio is in line with that risk. If you view it as separate pots you might have a different investment approach for each person’s assets,’ Horniman says.
Horniman suggests looking at ready-made portfolios, funds that are risk rated or target return funds which aim to generate the return you need in as low risk a way as possible.
‘Whichever route you take, remember the old adage that money is like manure. It needs to be spread,’ he adds.
Martin Jarvis, associate consultant at financial advice firm Mattioli Woods, says if an investor’s bills are covered by their pension, they could be more adventurous with their ISA portfolio.
However, if one of your goals is to buy a dream car, you’ll need to think about when you’ll need the money. In general, if you have a short investment time horizon your attitude to risk will be lower because you won’t have time to ride the stock market’s highs and lows.
‘Typically, high-risk offers potentially high returns so investments in equities or, more specifically, mid to small cap in the UK and abroad. Investments in emerging or developing economies, which have the highest volatility, could in turn offer the highest potential return or, indeed, loss,’ says Jarvis.
Lamb at Almary Green suggests keeping a cash buffer to call upon if unforeseen expenditures crop up. This would avoid having to access the more adventurous investments during periods of short-term market volatility.
He reckons adventurous investors could consider a global equity fund. This would spread the risk across different geographical areas, with the manager making decisions over the splits.
‘This might be preferable to selecting a number of single-sector funds because the manager could pursue global themes, adjusting the country allocation according to markets,’ he explains. An example of a global equity fund is Newton Global Equity (GB00B8376K50).
Newton Global Equity
5 year annualised return: 14.6%
Ongoing charge: 0.8%
Newton Global Equity seeks long-term capital growth by investing in a portfolio of global stocks. It identifies themes which encompass major areas of change in the world and uses these themes as the basis of its investment ideas. The goal is to outperform the MSCI AC World Index by 2% a year. The fund typically has 60 to 90 holdings.
Top holdings include Microsoft, Apple, Citigroup, United Technologies and Japan Tobacco.
Using an ISA for lower risk assets
Colin Low, managing director at Kingsfleet Wealth, says an alternative investment approach would be to put lower risk assets into an ISA and higher risk, longer-term assets in a pension.
He suggests holding some of the portfolio in funds which offer limited growth but also low levels of volatility, such as Pyrford Global Total Return (IE00B1XBN520).
The product has a five-year annualised return of 4.3% and 1.07% ongoing charge. It seeks to provide a stable stream of real total returns over the long-term with low absolute volatility and significant downside protection.
The fund invests in asset classes and securities which the manager believes offer fundamental value. It invests in investment grade sovereign debt securities and equities that have a minimum market cap of $500 million.
It emphasises North America, Europe (including the UK) and Asia Pacific (including Japan). The fund currently has 56 equity holdings and 13 bond holdings.
The decision of whether to top up your existing investments or buy something new depends on how many holdings you already have in your portfolio and what they are.
Legendary US investor Warren Buffett said on several occasions that a portfolio of 12 to 15 stocks would give ample diversification; provided they are from a range of industries.
Russ Mould at AJ Bell Youinvest says if your portfolio contains just funds, then a lower number of funds would provide the same level of diversification because they could contain hundreds of stocks as well as fixed income securities. This approach would help to keep costs down.
Patrick Connolly, head of communications at financial advice firm Chase de Vere, says if you already have a diversified investment portfolio which is suitable for your needs then there is probably no need to change strategy.
‘In these circumstances, it is usually best to review and then top up your existing holdings. This keeps your portfolio manageable, as you won’t have too many different investments, and on track,’ he explains.
It may be that you want to take more risks with your extra £5,000 in the hope of generating better returns. Connolly says investors could do this but should be wary of steering away from their long-term strategy. If you take more risk, there is more chance you will lose money.
What's popular with investors now?
Fundsmith Equity (GB00B41YBW71) is one of the most popular funds with investors at present, according to lists published by various investment platforms. It invests in high quality stocks, even if they are expensive, because it believes these will do well over the long-term.
The fund has achieved a 21.8% annualised return over the past five years and has a 0.97% ongoing charge. Its top holdings include Stryker, IDEXX Laboratories, PepsiCo and Philip Morris International.
Why time horizon is so important
Younger people can usually afford to take more investment risk because they have more time to claw back any short-term losses. Connolly says a young investor’s focus can be solely on capital growth, meaning they could invest almost everything
‘Even if stock markets fall, this simply means they can buy their investments at a cheaper price until markets recover, which pushes down their average buying price,’ he explains.
As people get older and the value of their investment portfolio grows, they need to consider capital protection as well as capital growth. This is particularly important for investors who will be relying on their investments to help generate an income when they retire.
Don't ignore your portfolio
To ensure you don’t end up taking too much or too little risk, Connolly advises rebalancing your portfolio regularly. This involves selling some of your investments which have performed well and now represent a larger proportion of your portfolio. You might want to reinvest into ones which have performed poorly and are now a smaller proportion of your portfolio.
Connolly recommends reviewing and rebalancing your portfolio every six or 12 months. If you do it any more often, the charges involved could outweigh the benefits.
For example, let’s say you invested £10,000 a year ago in each of the average US equities, emerging market equities, UK gilts and absolute return funds.
Based on their respective performance over the 12 months to the present day, you would now have £13,780 in US equities, £13,800 in emerging market equities, £10,670 in UK gilts and £10,360 in an absolute return fund, changing the risk profile of your portfolio considerably.
Rebalancing ensures you don’t take too much risk. Selling investments that have done well in favour of those that have done badly means you are effectively locking in profit and then buying cheaply.
‘This is the holy grail of investing and something which very few investors consistently achieve,’ notes Connolly. (EP)
Dan Coatsworth, who edited this article, has a personal investment in Fundsmith Equity.