By GRAHAM FROST 03/08/2007
Stock market volatility is always a timely reminder to ensure your portfolio is well diversified and that you are not taking excessive risk. Provided your portfolio is ship shape and you are investing for 5-10 years or more, then you shouldn’t lose too much sleep over shorter term market fluctuations. However, if you are nervous about making further investments, there are still a number of potentially attractive routes open to you.
Firstly, consider investing on a monthly basis. This means that if markets do fall you’ll be buying units/shares at a lower price and hence benefit when markets subsequently recover (known as ‘pound cost averaging’). Capital protected plans could also hold some appeal, as these typically offer full capital protection over terms of around 5 years as well as participation in stock market growth. These plans do not benefit from dividends, so usually lag conventional funds and trackers when markets rise, but do at least give potential for better than cash returns. Our advisers can assist you with both of these options and you can view our protected plan research here.
Thanks to rising inflation, Index-Linked Gilts, where both the redemption value and annual coupon rise inline with the Retail Price Index (RPI), currently look attractive compared to conventional Gilts. The breakeven rate of inflation (at which returns from Index-Linked Gilts equal conventional Gilts) for higher rate taxpayers is currently around 2-3%, so if you believe RPI will remain above this (June RPI was 4.4%) these investments merit consideration. However, bear in mind that you can lose (or make) money if you do not buy at issue and hold until redemption.
If you prefer the security of cash then take a look at National Savings Index-Linked Certificates, which also benefit from high inflation. Returns are again linked to RPI and, as an added bonus, are tax-free. For example, the 3 year 15th Issue Certificates currently pay RPI plus 1.35% which, based on June RPI of 4.4%, equals a gross annual equivalent of 9.58% for higher rate taxpayers. The 5 year certificates currently pay the same rate and individuals may invest up to £15,000 in each issue.
The Leeds Building Society also offers an innovative inflation-linked bond, paying RPI plus 3% gross until 31 August 2009. This is far more generous than National Savings, but returns are taxable. Based on RPI of 4.4% the gross rate is a very attractive 7.4%, falling to 5.92% after 20% tax and 4.44% after 40% tax.
Rising interest rates mean that conventional savings accounts are also looking more attractive than they have done for several years, although higher inflation does remove some of the shine (as it reduces the ‘real’ return). For smaller investments the National Savings Direct Cash ISA is hard to beat at 6.3% tax-free, equivalent to 10.5% gross for higher rate taxpayers, although this does subsequently restrict the use of your maxi ISA allowance. With a little shopping around it’s also possible to get over 6.2% gross on instant access savings accounts, although higher rate taxpayers should note that the net return will be below the current rate of inflation (RPI).
If you believe interest rates have more or less peaked then fixed rate bonds look attractive, for example Birmingham Midshires is offering 6.7% gross on its 1 year internet bond. Higher rate taxpayers can also benefit from competitive Guaranteed Income Bond (GIB) rates, thanks to a small tax advantage over savings accounts. Interest is quoted and paid net of basic rate tax (which cannot be reclaimed by non-taxpayers) and higher rate taxpayers pay a further 20%, i.e. £100 gross equals £80 distributed with a further £16 tax to pay for 40% taxpayers, leaving £64 net. On a savings account £80 distributed must be grossed back up to £100 and 40% deducted, leaving £60. In practice, this means that ‘best buy’ GIB rates pay the equivalent of around 7% gross for higher rate taxpayers. GIBs also offer potential tax deferral benefits.
We are often asked whether there is any benefit in holding money in offshore bank accounts. If you are UK domiciled and tax resident the answer is a simple no, as interest earned must still be declared and tax paid via annual self-assessment tax returns, regardless of whether the interest is actually remitted to the UK. The EU Savings Directive also means tax is withheld unless the bank concerned passes information to HMRC.
Finally, if you have a mortgage and cash savings then consider an offset mortgage. The savings can be used to reduce the mortgage balance and hence the amount the mortgage interest you pay each month. The upshot is that you earn the equivalent mortgage rate, tax-free, on your savings. If you subsequently need to use the savings you can simply withdraw money as required and the mortgage balance increases. On a mortgage rate of 6.5% your savings would earn the equivalent of 8.12% gross for 20% taxpayers and 10.83% for higher rate taxpayers. For more details call our mortgage team on 020 7189 9980.
Please note your home may be repossessed if you do not keep up repayments on your mortgage. Rates mentioned were correct as of 3 August 2007, but subject to change.