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.
It's bonus time: How to start investing your free Lifetime ISA money
The first Government bonuses are now being paid into Lifetime ISA accounts, so how should you deploy the money? We discuss the potential strategies for individuals depending on whether you are saving up to buy your first home or keeping the money locked away until you turn 60.
We debate the merits of keeping your Lifetime ISA in cash or investing the money in the markets. We also give 10 investment ideas throughout the article.
HOW MUCH FREE MONEY CAN YOU GET?
The Lifetime ISA is one of the most attractive developments in the savings and investment industry for a number of years. At the heart of its proposition is a 25% cash bonus from the Government, meaning you get up to £1,000 free each year in exchange for investing up to £4,000 annually of your money.
Going forward bonuses will be paid every month. However, the Government said it wouldn’t pay any bonus for deposits made in the 6 April 2017 to 5 April 2018 period until the end of that tax year. It’s that bonus money which is now beginning to reach eligible customers’ accounts.
You don’t need to fill out any forms or call anyone to get the bonus payments. All the hard work is done by your Lifetime ISA provider as they apply to the Government on your behalf and the money is expected to be added to your account within four weeks.
HOW MUCH HAVE PEOPLE INVESTED SO FAR?
AJ Bell Youinvest says the average amount invested so far in its Lifetime ISA accounts is £2,250, so the average Government bonus will be £562.50. Eight out of the top 10 most purchased investments in its Lifetime ISA accounts have been passive funds, or in other words index tracker funds.
What are the main features of the Lifetime ISA?
Anyone under the age of 40 can open an account.
Pay in up to £4,000 a year and receive 25% cash bonus from the Government.
Bonus paid until you reach age 50.
Penalty-free and tax-free withdrawals if using money to buy first home or you have critical illness.
For all other circumstances, money locked away until age 60 unless you pay 25% penalty on the value of the withdrawal.
How to manage your Lifetime ISA money including the bonus payments all depends on what you are saving for. Read on to learn about suggested routes using a number of different scenarios.
SAVING TO BUY YOUR FIRST HOME
1. GOAL: BUY IN THE NEXT THREE YEARS
We believe you should keep your savings in cash if you want to buy a property within the next three years.
If you put your money in stocks and shares, imagine how frustrated you would feel if the stock market experienced a bad period and the value of your Lifetime ISA fell during those three years.
You may not have enough time for the market to recover in value before the point at which you want to buy your property. Investing in general is a long-term game.
The downside of keeping your money in cash is the threat of inflation eating in to the real value of your assets.
HOW MUCH CAN YOU GET FROM A CASH LIFETIME ISA?
Skipton Building Society is currently the only provider to offer a cash Lifetime ISA product, paying a 0.75% interest rate. Stocks and shares Lifetime ISAs are unlikely to pay very generous interest rates on cash holdings, if at all.
Just remember to keep your cash in the Lifetime ISA wrapper in order to qualify for the Government bonus. You may be tempted by more generous rates of interest from non-ISA savings providers such as Atom Bank, currently paying 2.15% on a three-year fixed term savings account, but moving your cash out of the Lifetime ISA and into a standard savings account means you would no longer qualify for the Government bonus.
Taking money out of a Lifetime ISA would also require you to pay an early withdrawal penalty equal to 25% of the amount you are withdrawing, meaning you could potentially get back less than what you paid in. You can only withdraw money without penalty if you are buying your first home, have reached age 60 or are terminally ill.
2. GOAL: BUY IN THE NEXT SEVEN YEARS
An average deposit for first time buyers is about £33,000. Saving the maximum of £4,000 per year in a Lifetime ISA plus the Government’s £1,000 annual bonus would mean you have enough money in six to seven years, based on 3.5% annual return. Our calculations assume £416.66 is deposited monthly including the Government’s bonus.
Clearly you would have to consider investing your money to get such a level of annual return in seven years or less, as it would be impossible to obtain such returns if you kept your money in cash.
Someone aiming to buy a house within a three to five year period would have to either generate a greater return than 5% each year to hit the average deposit figure, or they would have to have already stashed away some cash to help top up any money sitting in a Lifetime ISA.
If you are investing for a three to five year period, don’t take excessive risks in order to achieve a high return. There is also a chance the markets will experience a bad patch during that time period, based on historical trends, so you mustn’t expect your capital to consistently grow during the investing timeframe.
The same applies for saving over a seven year period as that is still deemed quite a short length of time in the investing world. Unless you’re an expert in stock picking and an experienced investor, we would steer clear of individual shares for this investment scenario and stick with funds which offer diversification as they should each hold numerous assets.
For this scenario, we suggest you put your money into a mixture of broad-based products including a multi-asset fund; a low-cost exchange traded fund which tracks an index of large companies around the world; and a fund where the manager pays a lot of attention to avoiding monetary loss rather than simply chasing opportunities to make money. The following examples fit the bill:
VT AJ Bell Passive Balanced Fund (GB00BYW8RX12)
This is an ideal multi-asset fund for someone seeking to start building up a decent diversified portfolio. The AJ Bell product contains a mixture of low-cost exchange traded funds with an asset allocation of approximately 42% in shares, 42% in bonds and 10% in property and the rest in cash.
The product only launched a year ago, so there is no long-term performance history. There are four other versions of the fund which provide different asset allocations to the core asset classes, structured in a range from cautious to adventurous to match your risk appetite.
Fidelity Index World (GB00BJS8SJ34)
This fund will give you exposure to many of the biggest and best known companies in the world. It tracks the MSCI World index which contains large and mid-cap stocks from 23 developed market countries. Constituents include Apple, Johnson & Johnson and Bank of America.
‘We think that this low-cost fund offers a sensible approach to gain exposure to the global equity market,’ says financial data expert Morningstar.
Troy Trojan Income (GB00B01BP176)
We like this fund for its well-defined approach and quality fund manager in the form of Francis Brooke. It has a bias towards large and mid-cap stocks with a focus on quality, low capital intensity and typically low cyclicality of earnings. Current holdings include banking group Lloyds (LLOY) and catering giant Compass (CPG).
The fund is conservatively run and asset manager Troy prioritises the avoidance of permanent capital loss. All of its executive directors and fund managers are significant shareholders in the asset management business and its funds. That means they share the same interests as retail investors in the funds.
3. GOAL: BUY IN THE NEXT EIGHT YEARS OR MORE
Many experts believe the longer the investing timeframe, the higher the risks you can afford to take. That said, risk appetite is down to personal choice and there is nothing wrong with staying cautious or less adventurous for any period of time.
The three previous product examples also apply to this investing timeframe. You may also wish to consider a higher risk selection such as a smaller companies fund and an actively-managed global equity fund.
The following products look ideal for inclusion in a Lifetime ISA if you are investing for at least eight years, although they shouldn’t be the only holdings in your portfolio.
BlackRock Smaller Companies Trust (BRSC)
Small cap firms can often enjoy faster growth in earnings and their share price than large businesses. This fund has a great track record and fund manager Mike Prentis is highly regarded in his field as a good stock picker in the small cap space.
He seeks cash generative companies led by a strong management team with a decent market position, as well as a robust balance sheet and track record of growth. The portfolio currently includes recruitment agency Robert Walters (RWA), brick maker Ibstock (IBST) and engineer Avon Rubber (AVON).
Witan Investment Trust (WTAN)
This investment trust uses the services of many different fund managers, each experts in certain areas. You get exposure to companies quoted on stock exchanges in various parts of the world including North America, Europe, Japan and Asia.
The product is also good for a growing stream of income. It has raised its dividend every year for the past 43 years. We suggest you consider reinvesting dividends during the accumulation stage of your Lifetime ISA to enjoy compounding benefits.
SAVING FOR RETIREMENT
A Lifetime ISA can be viewed as a supplement to your pension – or money to enable you to do tasks such as clearing your mortgage before you retire or fund all the bills and lifestyle fun in the early stages of retirement so you can prolong drawing on your pension.
Whatever the decision, you have time on your side. Anyone investing in a Lifetime ISA will currently be no older than 41 years old, remembering that you had to be younger than 40 years old to open an account when they first launched in April 2017.
If you aren’t going to use the money to buy your first home then you’re looking at a minimum of 19 years before you can withdraw the funds from your Lifetime ISA without penalty (age 60 onwards).
Therefore you have a really good amount of time in which to keep adding money to your account and let you investments grow in value over the coming years.
ARE THERE TAX BENEFITS?
All withdrawals from Lifetime ISAs will be free of tax. You also don’t have to pay any tax on capital gains or dividend income generated by the assets inside the Lifetime ISA. This makes them very appealing for individuals looking to get the most from their money in later life.
In comparison, pensions enjoy a benefit from tax relief – essentially another form of Government bonus – when you put money into your account. You can withdraw 25% of your pension tax-free but the remainder is treated as earned income and may be liable to income tax.
BUILDING A LIFETIME ISA PORTFOLIO
There are some basic rules to portfolio construction. If you’re starting from scratch, consider having a group of investments that form a ‘core’, or in plain English the backbone to your portfolio. These will be solid picks that give you plenty of diversification.
The ‘core’ is likely to be a mixture of funds that contain stocks (also known as equities), bonds, cash and potentially property.
Once you’ve got that backbone in place, you can start to think about adding ‘satellite’ holdings which may be higher risk selections. These may include funds that target certain sectors, themes or smaller sized companies; or they may be geographic-specific funds such as emerging markets.
Some people prefer to buy individual stocks to get such exposure, although the risks would be much greater compared to a fund as the latter has a diversification cushion to minimise the effects of bad news affecting a single company holding.
Many investment experts believe a good strategy is to split your portfolio 80% in favour of the core component and 20% for the satellite component.
Some go further and suggest a balanced investor may wish to have 50% in shares, 35% in fixed interest (essentially bonds) and 15% in property – but ultimately there is no one-size-fits-all asset allocation model.
TREATING THE LIFETIME ISA DIFFERENTLY TO A PENSION
If you’ve already got a diversified portfolio via your pension, you may wish to be more adventurous with your Lifetime ISA.
Experienced investors with proven stock picking skills can use the wrapper for short-term trading ideas and/or long-term investing ideas. Others may wish to buy something and forget about it; or at least not worry about day to day changes in valuation.
The ideas earlier in this article under the house buying section are also valid for someone using a Lifetime ISA to save for later life (age 60 and beyond). Here are five more ideas:
Foreign & Colonial (FRCL)
This product, which has proposed to change its name to F&C Investment Trust, has increased its dividend every year since 1971 and boasts an excellent track record of delivering superior returns to shareholders.
Around 95% of its portfolio is made up of overseas investments. It seeks to invest in well-established companies on major stock markets, rising stars in developing economies and less-liquid investments including private equity.
Current holdings include US health insurer Anthem; Booking Holdings which owns various online travel brands including Booking.com and Priceline.com; and payments technology
Investec UK Alpha (GB00BJFLDM36)
This fund seeks to outperform the FTSE All-Share index by 3% to 5% each year. Fund manager Simon Brazier has earned a great reputation during his career which includes periods at Schroders and Threadneedle.
Brazier regularly meets the management of companies in his portfolio and he places a large emphasis on analysing a company’s track record, strategy and allocation of free cash flow (essentially the money generated from operations minus cash needed to be reinvested in the business to keep it competitive). The current portfolio includes stakes in Tesco (TSCO) and London Stock Exchange (LSE).
Fidelity Strategic Bond (GB00BCRWZS59)
A good diversified portfolio should have some exposure to bonds. We suggest you pop this Fidelity fund in your Lifetime ISA as its manager Ian Spreadbury has built up a strong reputation for successfully managing fixed income funds over a number of market cycles, generating good long-term returns for his investors.
‘The fund’s starting point is a 60% allocation to investment-grade, 20% to high-yield, and 20% to government bonds, but its makeup can vary widely,’ says Morningstar analyst Ashis Dash.
‘The managers focus on asset allocation and credit selection while keeping duration within a tight (relative to peers) four to eight-year range, to create a diversified portfolio that provides reasonable income while being mindful of underlying risk.’
We suggest you buy the accumulation version of the product whereby income is rolled up so you own more fund units instead of taking income in the form of cash. Longer term you should enjoy compounding benefits.
Legal & General (LGEM)
If you’re happy to hold individual stocks in your Lifetime ISA, Legal & General is certainly the type of solid business that could deliver slow but hopefully fairly steady gains over time.
Importantly it is a business that is willing to move with the times. For example, its mature savings business was sold to rival Swiss Re at the end of last year for £650m, getting rid of legacy insurance liabilities. The proceeds will allow it to focus on investing and annuities.
Trading on less than 10 times forecast earnings for 2018 and offering a prospective dividend yield of 6%, it’s great value with growth at a reasonable price.
We like data analytics, events and academic publishing firm RELX for its excellent track record and its position as a global leader in several different areas.
A forward price-to-earnings ratio of 17 times is not out of step with a long-term average of around 19 times and we would expect a buy-and-hold investor in the shares to benefit from solid growth in dividends and profit over time.
Recent concerns over the Elsevier scientific journals business look overdone. In our view there is no immediate risk of an aggressive pursuit of open access – essentially research being given away for free – though investors should keep tabs on this issue.