I’ve have £200,000 to £250,000 to invest but have no idea of where to invest or how to invest. Also what sort of return can I expect to get?
This is a big question so it will take a big answer. I’ve broken down my answer into sections to help you navigate and jump to any sections that are of particular interest.
- First of all seek independent financial advice
- Investing for income, growth or both?
- Attitude to investment risk
- What might you invest in and what are the likely returns?
- Building a Portfolio & an asset allocation tool
1. First of all seek independent financial advice
The first thing I would suggest is to seek independent financial advice as your wider personal and financial circumstances need to be taken into consideration before you do anything. For example, how old are you? Are you a high rate income tax payer? Are you married? If so you may want to put investments in your wife’s name if she is a non-tax payer? Do you have outstanding debts? How much do you earn? Are you investing for income or capital growth, or both? What is your attitude to risk? What is your investment timescale and do you need access to the capital?
So of course I can only give generic information about investing but I want to give you some idea of your options.
2. Investing for income, growth or both?
As stated above, your personal circumstances will in part determine where and how you invest along with your investment objective. Broadly speaking investment objectives fall into one of 3 categories 1) investing for income 2) investing for growth and 3) a combination of the two.
If you need to draw an income from your investments then those that will meet your objective most effectively will be income generating assets. This can include rental yield from property, dividends from company shares with good dividend payment histories, coupons from bonds, interest from cash deposits etc. The key is that if you are truly focused on generating income then you may need to accept fluctuations in the capital sum invested, especially if you take on more investment risk in search of a greater level of income.
If you are investing for growth generally speaking this can involve a greater level of risk as investors are focused on the long term return before needing to draw on their investments, giving time for the value of the investments to recover from any market downturns. By way of example a company which historically hasn’t paid dividends, instead reinvesting any cash in expanding the business hopefully rewarding investors through appreciation of its share price; would be classed as a growth investment.
Of course the third option is a combination of investing for income and growth where your investment portfolio would have a combination of such assets. But as you can see a certain type of asset can fit into both categories – it largely depends on the actual asset held. For example shares (equities) can be income producing (good dividend payers) or growth as described. But the power of compounding income (i.e. the income generated being used to buy more of the asset rather than being spent by the investor) can lead to significant investment returns in the long term. In fact, it has been shown that the majority of stock market returns come from reinvesting dividends.
3. Attitude to investment risk
Different people have different attitudes and tolerances to investment risk. For starters if the thought of seeing the value of your investment fall will keep you up at night then you probably shouldn’t be putting your money anywhere other than in a bank account. Short of the bank going bust or you being a victim of fraud (but there is even some protection against these) your only worry is likely to be the loss of buying power that the funds have, as inflation eats away.
But the more tolerant you are to investment risk the wider the range of suitable assets that you might use. And generally speaking the more risk you are willing to take the greater the potential rewards and the potential losses.
But understandably, novice investors may not have any real grasp of their attitude to risk but there are tools out there that can help – which I come on to later. But a good adviser will help you determine your attitude to investment risk..
4. What might you invest in and what are the likely returns?
Your investment objective and attitude to risk will help determine which assets are suitable. The range of possible assets to invest in is vast but below I cover the main types, including discussing the potential risks and returns.
For income investors buy-to-let property is one option. While property returns do tend to be uncorrelated to investment markets they are not without risk. Over the long term house prices have tended to beat inflation (around 2.8% above inflation per annum since 1960) but the housing market, like investment markets, experiences periodic price corrections and crashes. Just ask those people who were planning on downsizing their homes to release equity to fund their retirement. Many are now forced to carry on working after house prices fell once the property bubble burst in 2007.
For a buy-to-let investor concerned with rental income, the average UK property yield is around 6-7% but there are massive regional variations. Buy-to-let or any direct property investment shouldn’t be entered into lightly as property is an illiquid investment and there are often large initial capital outlays. My guide to buy-to-let covers all the factors you should consider including costs, likely returns and whether it is a good investment.
Although a lot of people think of cash as the starting place when looking to invest it can be the eventual destination.
With inflation in excess of most savings account rates the real value of money on deposit can be quickly eroded. With the withdrawal of the National Savings and Investments (NS&I) Index Linked Saving Certificates savers have been struggling to find an alternative.
Typically the only way to earn a higher rate of interest from a savings account is to lock your money away for a longer fixed term. Even these rates usually fall woefully short of inflation. However, there are some savings bonds available on the market which will provide inflation beating interest rates and the good news is that they can be held in a cash ISA, so returns can be tax-free.
But one word of warning. These bonds will either restrict access to your capital during the term of the bond or impose penalties if you wish to withdraw your money early.
If you do decide to put your money into a savings account then you may wish to limit the amount held with any financial institution to £85,000 (£170,000 for a joint account). This will ensure your savings are covered by the Financial Services Compensation Scheme should your chosen bank go bust. For more details read my article ‘How to protect your savings from your bank going bust’. Of course, National Savings and Investment bank accounts are 100% back by the Government so represent no investment risk. Unsurprisingly the returns from these products are not the most competitive.
It is possible to invest directly in shares and hopefully receive and income stream via regular dividend payments along with a bit of capital appreciation (for which you can use your annual capital gains tax allowance to receive tax- free, or at least in part) . Whether dividend or capital growth are more important to you will depend on whether you are investing for income or growth. Direct equity holdings carry much higher investment risk and hopefully rewards. The problem is that if you get your timing or research wrong you can swiftly find yourself sitting on a huge loss and no income stream. (that’s exactly what happened to people who invested in banks in 2008). As for average returns, the Barclays Equity Gilt Study claims that equities have produced an annual return of around 5.4% over the last 50 years but this does mask huge crashes and market rallies. As ever past performance is no guide to future returns. In terms of income then it clearly varies on the shares held and the markets they operate in. But at the moment a good dividend paying stock in the UK might yield around 4% a year.
Corporate bonds are essentially loans to companies paying you an interest payment (a coupon) and your original loan amount back at an agreed date. The riskier the company the more likely they are to default, so the greater you potential return by way of compensation. But as ever with greater risk comes the potential for greater loss.
At the safest end of the spectrum we have Gilts (which are loans to the UK Government) through to investment grade bonds (companies with good credit ratings) through to non-investment grade and high-yield bonds (loans to companies with poorer credit ratings). Like equities it is possible to hold bonds directly and a number of companies (such as Tesco) have even marketed their bonds directly to the public. These are called ‘retail bonds’ but watch out as these are not always covered under the Financial Services Compensation Scheme (FSCS) should the company default.
Bonds are deemed lower risk than equities and their typical annual return over 19 years has been around 2.5%. But as ever past performance is no guide to future returns. A typical bond in the UK with a maturity date of around 5-15 years will provide an income in the region of 5% a year, but usually no growth in that income.
The above are just a few of the main investment asset classes. There are others such as commodities and hedge funds but I don’t wish to bamboozle you. The main point being you have a wide choice of assets which can produce growth and or income..
But up until this point I have talked about holding assets directly. Placing all your money into a single asset (such as one company’s shares) is akin to putting all your eggs into one basket. However, most people invest via an investment wrapper (or product) in a number of investment funds which themselves invest in a range of assets.
When you invest two things to consider are ‘how’ you invest and ‘what’ you invest in. The ‘how’ is whether you invest via pension, investment bonds, collectives etc. While the ‘what’ is usually the underlying investment itself, such as equities, bonds, property etc.
Without trying to oversimplify investment but think of it like a car. In order to get from A to B (ie your current situation to your desired stage in life) you need to choose a car. The car that best suits you will depend on the journey you plan to take, your current budget etc. Every car will have different running costs, tax etc and not one car suits all. Think of this as the investment wrapper (pension, Stock and Shares ISA etc). Once you have chosen a car you need to put petrol in it to get you to your desired destination. This is akin to the underlying investment choices. Clearly the petrol drives performance but the car can enhance it. But obviously it’s no good buying a Ferrari if all you plan on doing is going to the shops and back each day. It’s a similar thing with investment – excessive costs can wipe out any benefit. A good financial adviser can help you make the investment decision that suits you and your plans.
Below is a selection of investment vehicles. Each is taxed differently and has its own rules when it comes to access and drawing an income which a financial adviser will be able to explain in full detail.
Unit trusts/Investment trusts (collective investments) – these are pooled funds where lots of investors’ money is combined and the fund run by an investment manager with a certain brief. This enables investors to benefit from the economies of scale enjoyed by institutions and diversify by having a share in a fund that has a large number of holdings. The manager’s brief can be based on the asset type such as bonds, property, shares, a geographical region or a theme. The fund manager will buy and sell a much larger range of holdings which will hopefully reduce exposure to a single company’s share for example. If collective investments are held directly then they are subject to income and capital gains tax
Stock and Share ISA – this is simply a tax wrapper and can hold cash, shares and collective investments (funds) as described above. The benefit of investing via an ISA is that income and capital gains are tax free but you have a limited subscription each tax year (£11,280 for 2012/13 tax year).
Pension – defined contribution or personal pensions are another tax wrapper offering income and capital gains tax free growth. Again you can invest in the aforementioned assets and collectives (but not residential property).
Investment Bonds – these are products that are offered by life insurance companies that are subject to income tax. Their investment flexibility is usually limited to a range of investment funds.
5. Building a Portfolio & an asset allocation tool
By building a portfolio it is possible to diversify your investments so as to not put all your eggs in one basket. Consequently, other than your investment amount, there is nothing to stop you spreading your risk by investing in a range of asset with which to provide an income or growth. By choosing the right combination of assets and investment wrapper/product to suit your circumstances you can enhance your returns. This is what a good financial adviser would do for you. This value added is often overlooked by investors who concentrate solely on investment performance. While investment performance is important so is tax efficiency, suitability and risk.
So what assets should you invest in? I am fan of tools that bring complicated concepts to life. The investment tool below has been created by Fidelity FundsNetwork. They are often referred to as a fund supermarket as they sell thousands of unit trusts (as described above) which invest in lots of different things, from shares to property.
Interactive investment tool (give it a few seconds to load)
This interactive (and fun?) animated tool asks you a few simple questions such as your age, what you are investing for (rainy day?), your view on taking risks etc and then designs an example asset allocation for you.
By asset allocation I mean how much you should be investing in UK company shares, how much you should be investing in property unit trusts etc. For those who already have investments its also a great way to check your current asset allocation is right for you.
The tool then allows you to choose and purchase funds (unit trusts) if you so wish. But as I said before seek financial advice if you are unsure. In this instance read my article 10 tips on how to find a good financial adviser
And that’s it! If you’ve found this article useful and appreciate the effort that I’ve put into it please share it via Twitter, Facebook, stumbleupon etc. I’d really appreciate it.
I’m off for a lie down as I’m exhausted after that.
Money to the Masses