Personal Investments

There are numerous different types of investments available. Following is a précis of the types of asset classes that you may like to consider.

Cash

Clearly, the key benefit of bank or building society deposits is that the capital in actual terms will be secure, providing the interest only is withdrawn. However, once capital begins to be eroded by way of excessive withdrawals, it will become difficult to sustain a level of income.

The downsides of cash, particularly in this low inflationary environment is that interest rates are generally low and even investing into a high interest bearing account paying equivalent to the Bank of England base rate yields only 5.25% gross per annum. In addition, this would be a taxable income that, assuming a basic rate taxpayer status, would reduce by 20% savings tax to 4.2% net per annum. As a higher rate, this would net down to 3.15% per annum.

Furthermore, income and capital may diminish in real terms. For short-term income production, however, cash is an excellent asset class to hold and indeed should always be included as part of a balanced, medium to long-term investment portfolio. The exact extent to which though will be dependent upon an individual’s attitude to investment risk and of course personal investment objectives.

Fixed Interest Securities

Fixed interest securities include predominantly gilts and corporate bonds. These may be purchased on an individual basis, as with stocks & shares, through a stockbroker. However, a more cautious investor may well find a collective investment approach to be more appropriate. These are funds whereby the manager invests across a broad range of such investments thus considerably diluting the risk and creating diversification.

Gilts are essentially loan notes issued by the Government as a means of raising finance.  Issued over short, medium and long terms, an initial investment grants the owner an entitlement to a fixed income or ‘coupon’ until the designated redemption date, and an underlying guarantee of the nominal value of the gilt at redemption.  Given that our Government underwrites UK gilts, the default risk is negligible, although they are not totally without risk. They are actively traded instruments, the capital value of which during their term is susceptible to fluctuations in underlying interest rates. 

Corporate bonds are very similar, although they are issued by companies rather than the Government.  Fund managers can invest into bonds issued by companies with differing credit ratings and because of this there is a greater risk to capital than investing into gilts. This is due to the increased possibility of default. Again this is managed by diversifying the portfolio in to a basket of bonds issued by many companies.  The upside of this increased risk is that there is greater opportunity to outperform those returns obtainable through investing in gilts alone.

In summary, although equities have consistently enjoyed greater returns, fixed interest funds are popular given their lesser volatility and steady income streams, and like cash should be considered as part of a balanced portfolio.

Yields can vary, although we would expect slightly higher returns than cash from gilts and premium credit corporate bonds with even higher returns from lower rated fixed interest securities.

With Profits Funds

With Profits funds are a popular concept for more cautious investors. The underlying asset mix is predominantly equity and fixed interest based. Their principal aim is to allow investors to participate in the potential rewards of the stock market, whilst ironing out the volatility and potential pitfalls. 

Clearly full participation in the growth is not achievable via these funds as an element of the performance has to be held in reserve to offset against those years where returns are not so healthy.  The result is a steady consistent return, which is obtained via application of annual bonuses and terminal bonuses.   Annual bonuses have declined significantly over the last few years, although terminal bonuses have increased to partially support overall returns.  The downside of this approach is the element of the unknown as terminal bonuses are only applied upon eventual encashments.

With Profit funds have a part to play if your aim is to achieve a steady, consistent return from your investment, although their popularity has waned due to the reducing bonuses and the lack of explicitness in regards to actual charges and returns within the underlying assets. Alternative similar concepts introduced by providers have proved popular.

Property

Property is an attractive investment because it offers prospects for a high increasing income and capital appreciation.  Caution should, however, be adopted in that property is illiquid and unlike other investments described below, cannot generally be partially encashed.  Rental yields will be liable to Income Tax and capital gains are subject to Capital Gains Tax (CGT).

An individual may buy property, both residential or commercial, directly with available cash or, after putting down a minimum deposit of typically 15%, may fund the remainder with a buy to let mortgage or commercial loan.  Purchasing property in this manner avoids committing most of your available resources to the purchase, thereby retaining a degree of liquidity within your funds.

The investment risk may be diluted somewhat by avoiding the direct ownership of property and instead, as per fixed interest assets, gaining exposure via a collective investment such as an Investment Trust or Unit Trust. These invest into property, although in this instance it is likely to be orientated towards commercial property. Property fund managers will construct a portfolio of commercial properties, including for example offices, retail parks and warehousing.

Structured as a collective or ‘pooled’ investment, these funds generally avoid the common downside of direct property investment of illiquidity by investing partially in property shares and/or cash, although this is usually only a small proportion of the fund.

Because of the dual opportunity to achieve positive investment returns via both rental income and capital appreciation, property could be considered a less volatile investment than equities, although not without risk. 

Equities

These are investments whereby you vest directly into the share capital of a company. Traditionally, these are regarded as the best performing asset class if assessed over the medium to long term. However, such outperformance is not without risk as the volatility of such investments is generally high as valuations are influenced by not only the company’s individual performance but also by external economic factors.

Any dividend payments made are subject to a 10% income tax credit, which is not reclaimable if you are a non-taxpayer. If you are a 10% or basic rate taxpayer, the 10% credit absolves you of any further responsibility. Should you venture into higher rate tax, then a higher rate liability shall be incurred, which equates to a further 25% of the net dividend (32.5% of the grossed up amount).

Any gains realised upon the sale of any holdings, whether these are for reason of liquidity or switching, are subject to Capital Gains Tax (CGT), although this can be offset against an individual’s personal CGT exemption. For the tax year 2008/09, this is £9,600 per annum.

The downside of direct shareholdings is the investment risk. This of course may be diluted via investment across a broad spread of different companies. However, the administration, from both a tax perspective and that of managing your holding, may become unwieldy. Investment into collective investments such as unit trusts or investment trusts are again alternatives to a direct holding. The tax treatment of these investments is the same as shares.  They are more attractive investments generally because they offer a spread of risk and because the trust manager can deal in shares within the trust without crystallising a tax liability and without the administrative burden. 

Unit and investments trusts are, however, sector specific and in order to move from an underlying investment of, say, UK equities to European equities, it is necessary to dispose of one holding and purchase another.  This creates additional costs as well as potentially crystallising a CGT liability. Within these investments, there is a wide range of fund options. As mentioned above, fixed interest or property exposure may also be obtained via these. Additionally, other investment options include managed and sector specific funds.

These can be held directly, with a view to utilising CGT exemptions. Alternatively, the underlying taxation of these can be varied by utilising different investment wrappers such as Individual Savings Accounts (ISAs), investment bonds and pensions.