Investing and personal wealth

This section of our site is aimed at those who are interested in investment products with more risk attached than a savings approach based on deposit accounts and ISAs, for example. Topics covered include: stocks and shares, unit and investment trusts and capital gains tax.

Open-ended investment companies (OEICs)

OEIC stands for open-ended investment company. Essentially an OEIC is a pooled investment fund of variable size in corporate form. Each fund will have an Authorised Corporate Director to protect the interests of the shareholders, and an Investment Manager will be appointed to manage the investments within the fund. The fund owns investment assets, for example stocks and shares, gilts, bonds and certain other financial instruments.

The size of an OEIC varies reflecting the market value of its underlying investments. It will also fluctuate as investors buy and sell shares in the fund as the OEIC has more or less property to invest. It is in this sense that it is open-ended. The value of each share in the fund will, broadly, reflect the values of the underlying assets.

An OEIC's investors own shares in the company rather than units as in a unit trust. The shareholders have the right to sell their shares back to the OEIC on any dealing day when trading has not been suspended.

The value of investments and income from them can fluctuate (this may partially be the result of exchange rate fluctuations), and investors might not get back the full amount invested. Past performance is not a guide to future performance.

Unit trusts

These are investment packaging, not direct investments.

Unit trusts are funds that are divided into units, where each unit represents a proportion of the fund (basically, the value of the fund’s assets divided by the number of units gives the unit price). To help cover expenses there is normally around 5% difference (spread) between the price that investors pay for units, and the price at which they sell them back.

A unit trust can be set up to invest in pretty well any area it likes, so it is very important that you understand the investment strategy being pursued by the managers.

The value of investments and income from them can fluctuate (this may partially be the result of exchange rate fluctuations), and investors might not get back the full amount invested. Past performance is not a guide to future performance.

Investment trusts

These are listed companies whose business is to invest such that the gains/losses accrue directly to the owners of the company.

Since the investment trust shares are openly traded, that means that if you want to invest in an investment trust, you simply buy the shares in the market. These are closed ended funds and shares must be available for sale for an investor to buy. Shares cannot be created for example in the way that a unit trust can create units to satisfy demand.

In order to represent the value at any time, the price of the shares should represent their proportion of the underlying value of the investment. However, the value is dependent upon the supply and demand for shares from investors and will normally trade at a premium or a discount.

The underlying investments in an investment trust could be from a wide range, including equities, fixed interest investments and property. Be sure you understand the investment strategy of the investment trust, as this is what will determine how risky it is likely to be.

Background

Investment trusts began in the Victorian era when the only way to invest in shares was to buy directly. This made it very difficult and expensive for small investors to invest in shares on anything other than a speculative basis. Even today if you want to invest in shares directly, and want a broad spread of investments without paying too high a percentage in fees, you should be starting with at least £30,000 to £50,000.

Therefore, some investors got together and formed a company, whose purpose was not to conduct a normal business, but simply to act as an investment vehicle for them.

This history is important because it means that investment trusts have the powers of any other company conducting business. Most importantly, this includes the following: -

Investment Trusts - Summary

Investors have to trust their fund managers rather more than they do in a typical unit trust or insurance company controlled fund.

This is because the managers have more powers.

The rule should be to select the investment trust that suits your requirements, and then read everything you are subsequently sent in case the managers are telling you that they have done, or plan to do, something that will change the nature or strategy of the investment trust in ways that you do not wish to be part of.

When choosing an investment trust, be sure to understand its attitude towards gearing i.e. borrowing, along with its underlying investment strategy – i.e. sector and risk profile. These are the key factors that influence the risk level of the investment trust.

The value of investments and income from them can fluctuate (this may partially be the result of exchange rate fluctuations), and investors might not get back the full amount invested. Past performance is not a guide to future performance.

Single premium investment bonds

These are investments packaged as life assurance, primarily designed for investment but with an insurance over-ride (often 101% of the investment value).

They are a very old type of investment policy, and thus are governed by some complex rules.

The funds are taxed, and because this is taken into account when you take benefits, as a general rule only higher and additional rate taxpayers (or those whose profit from the bond makes them such for the purposes of this computation) are likely to have any additional tax liability on gains.

By and large, older single premium bonds have been superseded by more modern unit-linked investments (governed by normal income tax and capital gains tax rules, within the funds).

However they still have some uses for people with particular requirements, especially those who have already maximised their use of other types of tax planning. Below are three features that can be useful for some people:

Taxation on investment bonds can be complicated - please see your financial adviser.

The value of investments and income from them can fluctuate (this may partially be the result of exchange rate fluctuations), and investors might not get back the full amount invested. Past performance is not a guide to future performance. The levels, bases and reliefs from taxation may be subject to change.

Offshore Funds

There is a lot of confusion about offshore funds.

They key issues are these:-

The value of investments can fall as well as rise and you may not get back the amount you originally invested. Past performance is not a guide to future performance.

Onshore and offshore bonds

Investment bonds are usually single premium life insurance contracts. They are sold by life insurance companies to allow customers to invest in a range of funds managed by professional investment managers. 

Bonds can provide long-term capital growth but can be used by individuals as a potential source of income.

Onshore and offshore

There are 2 types of bonds: onshore and offshore. They are structured in similar ways but the tax treatment is different.

With Onshore bonds the insurance company pays tax at a basic rate on income and gains, meaning basic rate taxpayers will have no further income tax to pay. 

Higher rate taxpayers may have to pay the difference between the basic and higher rates. Additional tax will only be due after a chargeable event (such as the surrender of the policy or the death of the policyholder) results in a chargeable gain. 

Offshore bonds are not taxed by the insurance company. However investors will be liable for income tax and any chargeable gains at their marginal rate.

There are more assets available to invest in with offshore bonds compared to onshore bonds. Investment types include:

Get in touch with our team to talk about investing.

Tax rules and allowances are not guaranteed and may change in the future. The value of investments can fall as well as rise and you may not get back the amount you originally invested.

Exchange-traded funds (ETFs)

Exchange-traded funds (ETFs) are index-tracked investment funds that trade on a stock exchange. They are generally used to track the performance of particular market indices.

An ETF holds a range of assets like stocks, commodities and bonds and they trade close to its net asset value over the course of a trading day. This means that they change in value over the course of a given day.

There are a number of different kinds of ETFs including:

Differences to mutual funds

The main difference between the two is that ETFs can be traded whenever the market is open. Like a mutual fund, an ETF collects together assets like stocks or bonds.

However, unlike a mutual fund, ETFs are listed on a stock exchange, providing investors with price transparency throughout the day and the ability to buy and sell holdings like trading a share, whereas mutual funds usually only price once a day.

ETFs generally also have lower costs associated with them than traditional mutual funds.

Safeguards

Most ETFs available in Europe are regulated under the European UCITS IV directive which provides a number of safeguards for investors:


The value of investments can fall as well as rise and you may not get back the amount you originally invested. ISA eligibility depends on personal circumstances. Tax rules and allowances are not guaranteed and may change in the future.

Venture capital trusts (VCTs)

A venture capital trust (VCT) is an investment company that has been approved by HMRC, is quoted on a regulated market and invests at least 70% of its assets in small unquoted companies (those that would qualify under the EIS).

Conditions

Aside from the type of companies it can invest in and the percentage of its asset portfolio that must be invested, there are other conditions for VCTs:

Income tax relief

If an individual subscribes for new ordinary VCT shares up to the value of £200,000 in a tax year they will qualify for 30% income tax relief.

Any dividend received in respect of ordinary shares in a VCT is exempt from income tax if the individual receiving it is over 18.

The shares must be held for at least 5 years to qualify for these tax benefits.

Gains

Gains made on the disposal of ordinary shares in a VCT are not considered to be chargeable gains. No capital gains tax relief is available for losses incurred.

The shares must be held for a at least 5 years to qualify for this tax benefit.

Tax rules and allowances are not guaranteed and may change in the future. VCT investments can be high risk and are not suitable for most investors. Specialist advice is essential to establish both eligibility and suitability for such investments. Whilst VCT investments may have significant tax benefits, the value of investments can fall as well as rise and you may not get back all, or even any, of the amount you originally invested.

Enterprise Investment Scheme (EIS)

The Enterprise Investment Scheme (EIS) is a government scheme designed to help smaller higher risk companies raise finance. It does this by offering a range of tax reliefs to investors.

The scheme is only open to companies from qualifying industries. On top of this, to be included in the EIS, a company must:

Conditions

Tax reliefs

There are a range of potential tax reliefs for investors associated with the EIS:

Tax rules and allowances are not guaranteed and may change in the future. EIS investments can be high risk and are not suitable for most investors. Specialist advice is essential to establish both eligibility and suitability for such investments. Whilst EIS investments may have significant tax benefits, the value of investments can fall as well as rise and you may not get back all, or even any, of the amount you originally invested.

Stock and shares - equities

Stocks and shares are the most widespread types of equity that most people will get involved with investment terms.

Equity investment can involve anything from investing directly in the stock of a single small company (not necessarily considered good practice i.e. generally a high risk investment), to investing in a fund that represents global markets and thus buys a very small element of hundreds or thousands of companies (which means that you should do as well overall as the overall global economy does) i.e. investment risk is distributed.

Equities are normally bought directly via a stockbroker, or packaged within unit trusts, investment trusts and life assurance bonds etc.

The value of investments and income from them can fluctuate (this may partially be the result of exchange rate fluctuations), and investors might not get back the full amount invested. Past performance is not a guide to future performance. Equity based investments do not afford the same capital security that is afforded with a deposit account.

Fixed interest securities

Fixed interest investments, also known as bonds and gilts, are those where a borrower agrees to pay a fixed level of interest for a fixed period of time, and then return the money or (in a small minority of cases) a fixed interest forever (or until you decide to repay).*

The most erroneous assumption is that, because such loans are only made to reliable borrowers, their money, or their return, is safe.

It isn't.

Profits in the fixed interest area are governed by three factors:

It is possible to invest directly in fixed interest areas.

Gilts
Gilts are loans to the Government, but most people will invest via some form of packaged investment. It is fair to say that only the more cautious investors actively opt for unpackaged non gilt fixed interest areas. In most cases exposure to this area is via professionally managed funds and investments where the manager uses fixed interest as one of the tools to produce the overall objectives of the investment.

*In some cases there is never a repayment, and the interest is paid forever (example - the permanent interest bearing shares and perpetual sub bonds issued by building societies).

The value of investments and income from them can fluctuate (this may partially be the result of exchange rate fluctuations), and investors might not get back the full amount invested. Past performance is not a guide to future performance.

Gilts

Gilts are contracts whereby a large body (a corporation or Government) asks to borrow money on the basis that it will then pay X per cent per annum for a period of time, and then repay the capital. They are a debt issued by that body. Think the reverse of a mortgage. Contracts issued by the UK Government are called gilts.

For example a £1 billion bond paying seven per cent until 1 May 2018.

If you are one of the people who take the bond when it is launched, the maths is easy. If you invest £100,000, you get £7,000 a year until 1 May 2018 and then you get your £100,000 back.

But now it gets tricky. Stop thinking about seven per cent and instead think about buying an income of £7,000 per annum until 1 May 2018. Once the bond starts trading in the market everyone pretty well ignores the seven per cent figure. It becomes irrelevant. What matters is the £7,000, and just how much would you be willing to pay for an annual income of £7,000, followed by a lump sum of £100,000 on 1 May 2018. (The current price of the bond will show the present market view).

The answer to this depends largely on the inflation and interest rate outlook at the time that you are thinking of buying. If the outlook is bad you might not want to offer more than £80,000. If the economy is doing well, with low inflation and interest rates, you might pay £120,000.

Which brings us to a discussion of the risk of bonds.

They are normally described as lower risk investments, which can be true, depending on the issuer i.e. Government bonds are low risk but corporate bonds may not be, depending on the rating of the issuing company. Bond funds are funds run by investment companies, and they may hold a number of bonds at any one time. Differing levels of risk are available depending on the composition of the fund. They may be fairly passive, holding bonds to maturity and then reinvesting the proceeds, or they may be aggressive traders in the market, or a mixture of the two.

Risks

The big, but most unlikely, risk is that the body issuing the bond goes bust. When a financially stable Government issues the bond this risk is obviously very low, and most larger companies are also safe, but companies (which issue corporate bonds), even big ones, can and do go bust, and bondholders have no special protection.

So, on this basis if you buy a bond (whether at outset, or in market) you know what your return will be if you hold it to the end of the bond's life, and given that bankruptcy is unlikely, this can be considered a low risk investment.

But if you buy the bond for £120,000, and sell it three or four years later for £80,000 you have made a big loss. This means that trading bonds (buying with a view to selling later for a gain) is not a low risk activity.

Very few investors actually trade bonds on their own account, but they do invest in bond funds (or corporate bond funds), and sometimes they do so thinking that such funds cannot fall. This is, of course, wrong.

There are plenty of good reasons to invest in bond funds, the two most common being for income, and/or to spread your money across a range of investments in order to minimise your overall risk, but it is essential that you make such investments with an understanding of the risks. We can discuss bonds and bond funds in more detail if you want.

The value of investments can fall as well as rise and you may not get back the amount you originally invested. Past performance is not a guide to future performance.

Hedge funds

The term hedge fund covers a very wide range of types and styles of fund, from high risk to low risk and from very complex to simple.

The basic principle is that the managers usually have a very high degree of autonomy and discretion concerning investment decisions.

They have a wide range of powers for making investment decisions including, for example, borrowing ('gearing') or creating completely new companies to buy and run, and hopefully later sell at a profit. It is absolutely essential that you read and fully understand the documentation concerning the specific fund in which you invest.

Background

The term hedge fund is historic – a hedge is a financial device that allows you to protect a position if the market falls, (as in to hedge your bets). For example a UK company agreeing to pay $1,000,000 (for the sake of argument equivalent to £500,000) on a certain date next year for supplies might be worried that the pound might fall, making the supplies more expensive. So they use a hedge, they pay a small fee that allows them to buy their million dollars for no more than £550,000. They are said to have hedged their exchange rate exposure.

The original hedge funds realised that they could use various financial instruments to make money in a falling market, as well as in a rising one (so long as they made the right decisions).

Hedge funds have a degree of glamour associated with them because for many years only the very rich could invest in them, and in the days of easy credit they developed a reputation for making huge profits for their managers, and for having the financial clout to move markets.

But as with all investment – ignore the glamour, make sure you understand their record, their methods, and the risks.

The value of investments can fall as well as rise and you may not get back the amount you originally invested. Past performance is not a guide to future performance.

Borrowing money

Most investment vehicles are funds run by companies where the basic rule is that they only invest the money that they have been given by individual investors.

Investment trusts and some funds can, however, borrow money (gearing). They tend to do so for the following reasons: -

  • To smooth cash flow - an investment trust might want to make changes in a portfolio (especially buying new stock) but not want to sell any current positions at the same time. It borrows the money, repaying later when it does sell. Such activity would be common in general broad-based equity-oriented investment trusts.
  • To take aggressive opportunistic positions - this is an extreme version of the above. The investment managers spot an opportunity and might want to commit significant assets to it, so they borrow the money. Investment trusts and funds that engage in this type of behaviour will normally be looking for one opportunity after another, and it should be clear from their description that this occurs.
  • To provide gearing to shareholders - all borrowing provides gearing, but in some funds where the aim is to take an aggressive approach to making gains (and which tend to always be using significant amounts of borrowed money, rather than just a bit from time to time), it might be explicit that the fund is geared.

The higher the gearing, the higher the risk.

For example a fund might borrow 50p for every £1 that its shareholders invest. Let's assume a current price of £1 per share.

If they do well and invest the £1.50 so that it grows to £3, the investors would get back £2.50, (the share price should rise to £2.50). A 100% fund gain produces a 150% gain for investors (before the interest on the loan is paid).

But if the fund managers turned their £1.50 into 50p, the lenders could call in the loan, get their 50p back and leave the investors with nothing.

  • The power to issue different classes of share - This allows companies to issue different types of share, with different rights. The differences in rights lead to differences in expected risk and return, and these are suitable for different types of investor. This reaches its full development in split capital investment trusts.

The value of investments can fall as well as rise and you may not get back the amount you originally invested. Past performance is not a guide to future performance. Certain investments, such as those that borrow, can be high risk and may not be suitable for most investors - advice is essential.

Risk and reward

Most people think that a high risk investment is one that is worth £10,000 today but could be only £8,000 next year, and that a low risk one is one where that £10,000 will be £10,100 next year, without fail.

This is however only half the story. What matters is the likely real return (which is the return after allowing for inflation).

Imagine that inflation is 3% a year, and that you can get 5% interest on a secure deposit (4% net after tax).

That £10,000 grows to £10,500, but because of inflation you have only made £100. This is secure, but is not going to provide a retirement nest egg.

(£10,000 increased by 5% is £10,500. Less £100 tax is £10,400. But inflation of 3% means that you need £10,300 to maintain the equivalent of £10,000. The result is a net gain of £100).

Now imagine the same scenario but this time you are going to invest in an area that has an element of risk.

While in any one year the risk of the loss may be too great to take (you need the capital to buy that house), if you are able to leave your money for a long time (5 years+) the good years may outweigh the bad.

The essence of risk is that you have to balance the possibility of short term loss against that of long term gain, and that reducing or removing the risk of short term loss can only ever be done by accepting limited growth. When comparing Banks and Building Societies with the stock market, investments do not offer the same security of capital which is afforded to bank and building society deposits.

Part of our role as a financial adviser is to help you determine your attitude to risk, and help select investments that will meet your needs.

Sensible investing

This is all about dividing your monies into various sections to cover all your needs, and of course meeting your risk-reward profile.

Most people will end up with something along the following lines:-

  • Emergency fund. A deposit account set aside to cover any planned short-term spending need or deal with an emergency (such as becoming unemployed and needing income while seeking another job).
    Each person needs a different amount, but we would normally consider less than three months' income would be insufficient for emergencies, although if you have more than a year's money on deposit then this is probably too much.
  • Investments to meet known expenditure within 1-5 years. These would range from deposit funds (e.g. for house purchase) to safe investments offering good rates of return over fixed periods (possibly deposits, perhaps National Savings, other fixed or near fixed rate of return investments).
  • Medium to long term savings. Given that the money is not expected to be needed for 5 or more years the whole range of equity-based and managed funds can be used in order to seek the maximum long term growth in the major world economies, subject to your attitude to risk.
  • Speculation. A speculative investment is one where the potential rewards are very high, but so are the risks. Speculative investments may not be an area that we normally get involved with, except perhaps to alert you to any that you may have. We do find that some people have bought them in error, or inherited them. The commonest speculative investments are direct holdings in small companies, AIM listed shares, and certain unit or investment trust holdings where the trust is in emerging or technology markets. 

The value of investments and income from them can fluctuate (this may partially be the result of exchange rate fluctuations), and investors might not get back the full amount invested. Past performance is not a guide to future performance. The levels, bases and reliefs from taxation may be subject to change.

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Capital gains tax

This is, to put it simply, a tax on capital gains.

Capital gains tax (CGT) is levied at 10% and 20% (10% up to the limit of the basic rate income tax band, 20% above it) for the 2017/18 tax year.

Rates of 18% or 28% apply to disposals of residential property that do not qualify for private residence relief and the receipt of carried interest.

Everyone has an exemption of £11,300 for 2017/18. Used carefully, this exemption can ensure that you need never pay capital gains tax when you come to turn your capital savings into supplementary income, provided that your disposals are relatively low in value. This allowance cannot be carried forward if unused.

Pre March 1982 assets
These are to be valued at their 31 March 1982 value.

Post March 1982 assets
Valued at cost.

Entrepreneurs' Relief
When you sell qualifying assets (i.e. a business) your first £10,000,000 of gains are taxed at a rate of 10%.

This is a lifetime limit and, for those who build and sell businesses on a serial basis, you can utilise part of this relief with each business sale until you have reached your limit.

Chargeable assets
Broadly speaking, if you sell, gift or otherwise dispose of any asset or property, unless such an asset or property is exempt from CGT, and make a profit on the sale or disposal compared to the price or value you acquired it for, you should assume that CGT might be applicable and seek advice.

Exemptions and reliefs
Exempt assets are free from CGT, whilst reliefs operate to reduce or eliminate a CGT liability in the event of the sale or disposal of certain types of assets, such as businesses. The relief applicable to most people is the Private Residence Relief for your main home. The sale of your home does not incur a CGT liability in most circumstances. If you have more than one house, we can advise you as to the best way to proceed.

Definition of disposal
There is no formal definition of disposal but, for everyday use, the two main events that are classed as disposals are the sale of an asset or the gift of an asset.

Gifts between spouses (living together) are not chargeable at the time of transfer, nor are gifts to certain charities. Most other gifts are chargeable, and it is important to take advice before making any significant gifts. For example passing a valuable heirloom to your child may result in a tax bill arising even though no money has changed hands.

The way in which tax charges (or tax relief, as appropriate) are applied depends upon individual circumstances. This information is based on our understanding of current HMRC rules and practice. Tax rules and allowances are not guaranteed and may change in the future.

The FCA does not regulate certain tax planning activities and services.

 

Turning assets into income and avoiding capital gains tax

For most people, capital gains tax (CGT) becomes a concern only when they want to turn long-term investments into income, typically when they retire and want to start using their savings to top up their pension.

In this event many people can avoid CGT altogether by careful planning in terms of how the gains and tax are calculated.

First of all, remember your exemption, and remember that you get this every year. This is the key. In 2017/18 you can realise a gain of £11,300 tax free, so for a couple that is £22,600. For people seeking to supplement their income by use of capital, this is often all that they need.

Also, in most cases, people do not suddenly need to move large blocks of investment from stocks into cash. In your sixties you might want to increase your income, but you still want growth over the next 25 years to sustain you in retirement.

Ignoring for the time being that many of your assets will be in exempt areas (such as ISAs etc), let us examine the case of you having built up your savings in a unit trust called DOSH.

  • You have amassed 100,000 units in DOSH, in joint names with your spouse
  • We'll assume that you paid an average of £1 per unit
  • Because it has done very well, the current unit price is £3.

So each unit you sell gives you a profit (gain) of £2.

  • If you encashed in the whole investment you would make a gain of £200,000 and pay a very large tax bill
  • However you simply want to top up your pension by £12,000 a year
  • To do this you encash 4,000 units at £3 each to give proceeds of £12,000
  • The gain is 4,000 x £2, i.e. £8,000
  • The gain is split between you and your spouse and amounts to only £4,000 each, which is inside your annual exemption. There is no tax liability
  • Provided that you are conservative and fund growth exceeds withdrawals you can repeat this every year for as long as you wish.

Knowledge of such techniques and the importance of advance planning and investment placement is one of the areas in which we can help you.

This information is based on our understanding of current tax law and practice, which may change in the future. The way in which tax charges, reliefs and allowances are applied depends upon individual circumstances and may also be subject to change in the future. This document is solely for information purposes and nothing in this document is intended to constitute tax advice. You should take professional advice before making any tax planning decisions.

 

 

CGT Tax Saving Tips

Our most common tax-saving tips are as follows:-

  • Moving assets across into investments that are exempt from capital gains tax (although care must be taken as any sales to move investments are likely to be disposals subject to CGT)
  • Timing disposals to spread across more than one tax year whenever possible (this means that part of the gain is taken in one tax year, and part in the next, allowing you to use two CGT annual exemption allowances. An example of this might be selling shares in blocks to fund a property purchase)
  • Transferring assets from an asset-rich spouse to an asset-poor spouse, so that both annual exemptions can be used in future disposals
  • Careful selection of which assets to sell in order to minimise tax or generate tax-free income. For example, all things being equal, using the exemption to dispose of all or part of those assets with the highest potential gain can be very effective.

The way in which tax charges (or tax relief, as appropriate) are applied depends upon individual circumstances and may be subject to change in the future. This information is based on our understanding of current HMRC rules and practice. Tax rules and allowances are not guaranteed and may change in the future.

The FCA does not regulate certain tax planning activities and services.

 
 

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