Investing Savings
The most important point when investing savings is to spread the risk over a number of different investments so that your fortunes are not dependent on one product.
In this chapter, six things that really matter:
~ Understanding investing
~ Selecting the investment period
~ Choosing tax-efficient investments
~ Other suitable investments for savings
~ Lump-sum investing
~ Investing as a non-taxpayer
There are many investment products that accept regular monthly payments. In other cases, where the minimum investment is low, and monthly savings are high enough, they can be invested directly. For example, National Savings certificates have a minimum of £100. Otherwise, savings can be put into deposit accounts until enough has been accumulated to make a lump-sum investment.
'Real' rates of interest, the difference between actual interest earned and the rate of inflation, are important. Since all interest is taxable, high interest rates can result in negative real rates.
Is this you?
•I have savings to invest but am nervous about seeking advice because I know I will not understand.
• I can save money but I just leave it in a building society.
• First there were TESSAs and PEPs; now there are ISAs - what are they?
• Are National Savings good investments?
• What is the difference between a unit trust and an investment trust?
• I don't pay tax; what investments are suitable for me?
Understanding investing
Fixed interest investments
These are investments where the income is a fixed amount, at least for the time being. Usually the capital value is also fixed, although in some cases it can change, too. However, either income or capital are fixed.
Equities
These are investments in ordinary shares of companies, where both the income and the capital can vary up or down.
They can be bought and sold on a stock exchange and they participate in profits and receive dividends, which are usually paid half-yearly.
Fixed interest versus equities
All statistics show that in the long run, due to capital growth, equities beat fixed interest investments by a big margin, whereas fixed interest may not even beat inflation.
Although the income on equities is less than on fixed interest to start with, it catches up and passes it in the long run. But to achieve the best returns on equities, it is necessary to have flexibility in the timing of both buying and selling.
Risk
The more you have invested and the longer you can leave it alone, the more risk you can afford to take with some of it, to achieve a higher reward. The most important thing is to recognise the existence of risk and to take appropriate steps.
Spread your investments over a number of different categories, having perhaps more than one investment in each category. Consider pooled investments such as unit trusts.
Choosing an investment category
The issues to consider are :
~ Do you want protection against inflation? Equities stand a better chance of achieving it in the long run and index-linked products can be considered for fixed-interest investing.
~ Do you want income? Income-producing equity investments can achieve growth as well.
~ Can you afford to take risks?
Questions to ask about any investment
~ Capital - does it remain unchanged or can it go up and down?
~ Income - is it fixed or variable? Is it paid out, kept in or reinvested ?
~ Tax - is income tax-free, taxable or taxed? Are capital gains taxable ?
~ Guarantees of income or capital - are there any?
~ Period of investment - is it fixed or variable?
~ Risks to capital or income - what are they?
~ Commission - is any payable and to whom?
~ Management fees - how much, if any. Are they initial and/or annual?
~ Past performance - what is it, remembering that it may not be maintained?
~ Future performance - what could affect it?
Monitoring your investments
It is essential to keep records: date of purchase or sale, quantity, price and value.
It is also a good idea to record successive prices, where appropriate, so you can spot a trend.
Another vital record is a diary of future events, such as the date National Savings certificates expire.
Selecting the investment period
If your saving objective is short-term, such as for a holiday or Christmas, a bank or building society deposit account is best. Instant access may not be necessary, so you could use a notice account, if you can get higher interest. From two or three months up to a year might be appropriate.
If you are saving for a period beyond, say, one year ahead, such as for a family wedding, fixed interest is probably still best. There are deposit accounts available for periods beyond one year. Alternatives are National Savings products such as savings certificates.
Because equity investments achieve much higher returns than fixed interest in the long run, they are very suitable for investment periods of at least five years, such as for your children's education or for your retirement.
Choosing tax-efficient investments
If you are a taxpayer you should first consider investments that are tax-efficient.
Short/medium term
National Savings with tax-free interest
Savings certificates are of two kinds: fixed interest and index-linked. They have two terms: two years and five years. The minimum is £100. Children's bonus bonds can be bought in units of £25 for a child (under 16). Premium bonds can be bought £100 at a time.
Longer term
Individual savings accounts (ISAs)
Most ISAs have savings schemes. The annual limit for investment is £7,000. Income and capital gains are tax free and dividends receive a 10% tax credit until 2004.
Investments can be of up to £3,000 in a cash component, £1,000 in an insurance component and up to the full £7,000 in stocks and shares.
Friendly societies
Friendly societies offer a tax-free investment linked to life assurance. The maximum investment is £25 a month or £270 a year. Income and capital gains in the scheme are free of tax and after ten years no tax is payable on withdrawal.
They are often promoted for children as they are a way of involving children's savings in equities, but most children are in a tax-free position anyway.
Savings-related share option schemes
If your employer has a scheme you should consider joining, as the tax-free benefits are significant. Options are given to buy shares at the current market price (sometimes even at a discount) at a later date, when hopefully the value has risen. Meanwhile, savings are made to pay for the options through a save-as-you-earn (SAVE) scheme with a bank or building society.
Other suitable investments for savings
Taxable National Savings
Most have minimum investment levels too high for direct investment of savings. The exception is capital bonds, which have a minimum of £100. They have only one term -five years - and the interest is kept in.
Unit trusts
These are a form of pooled investment consisting of a portfolio of shares managed by a professional company but owned separately by a trust. The price of a unit is the total value of the underlying investments divided by the number of units.
There may be an initial charge (up to 5%) included in the buying price. In some cases there is an exit charge instead, which reduces over a period. There is also an annual charge, usually 1%.
Most unit trust providers have regular savings plans for their products.
Lump-sum investing
When a lump sum has been accumulated in a deposit account it can be used to buy any investment. The following have not so far been mentioned:
National Savings
Products with a minimum of £500 include:
~ Fixed Rate Savings Bonds, which have lives of six months, 12 months, and two years. Interest can be taken out or left in and is taxed.
~ Pensioners' bonds for people over 60, with interest rates guaranteed for one, two or five years. Interest is paid monthly and is taxable.
~ Income bonds, with variable taxable interest paid out monthly.
Gilts
These are British government fixed-interest stocks. The most important factors are the interest rate and the redemption (repayment) date. There are a few stocks that have no redemption date.
The interest rate is fixed for each stock (or in some cases is index-linked) and, as they are traded on the Stock Exchange, the price goes up and down in accordance with prevailing interest rates. These movements become less as redemption date approaches.
The yield (interest as a percentage of current market price) is expressed in two ways - interest only and redemption, the latter also taking into account the time till redemption and the difference between the current price and the redemption price.
Interest is paid out half-yearly and is taxable (capital gains are not taxable).
Company fixed interest
These operate like gilts as the interest rate is fixed and so the stock market price varies. Interest is taxable but capital gains are tax free.
Guaranteed income bonds
These are managed investments which guarantee a relatively high return over a period, such as five years. The problem with them is that the capital value can be eroded.
With-profits bonds
These are pooled investments in the with-profits funds of life assurance companies, which are invested in a mixture of fixed interest, equities and property.
There is usually a minimum investment period (often five years), with penalties for earlier termination. Annual bonuses are declared but some growth is retained to smooth out returns and pay for terminal bonuses.
Direct investing in equities
It is advisable to spread your money over, say, ten companies, which means having at least £10,000 to invest, as it is not economic to put less than about £1,000 in any one, due to minimum dealing costs.
To spread the risk wider, shares can be bought in investment trusts, which are companies whose business is buying, holding and selling shares in other companies, so they make the investment decisions for you.
Investing as a non-taxpayer
If you do not pay income tax, avoid investments where the interest or dividend is paid after tax is deducted and the tax cannot be recovered.
Tax-free investments are not necessarily advantageous to the non-taxpayer; taxable investments on which the tax can be avoided or recovered might offer a better return.
Tax is deducted from bank and building society interest at 20% before it is paid but non-taxpayers can arrange to receive it gross by completing a form obtainable from the provider stating that their total income is below the personal allowance.
Summary points
* Remember that the return on equities easily beats fixed interest over the long run.
* Avoiding tax on income and/or capital gains is an attractive proposition but the saving needs to exceed any additional cost.
* Regular savings are particularly suitable for equity investment because of pound/cost averaging - when the stock market is low, you get more shares or units than when it is high, so that the average price for each is lower than the average of the prices each time you invest.
Do not put all your investment eggs in one basket - aim for a balanced portfolio including both fixed interest and equities.
* It is better for non-taxpayers to get interest paid gross than having to wait till the year end before tax deducted can be recovered.
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