The main types of investments are:
2/ Individual Savings Accounts (Stocks and Shares ISAs),
3/ General Investment Accounts (GIAs),
4/ Investment Bonds.
The first thing to understand is that each of the above are only ‘Wrappers’ with different rules that hold an underlying investment.
The underlying investment itself may be exactly the same ‘investment fund’ or ‘portfolio’ of investment funds for each of the wrappers.
The only difference between the investments is that the rules of each ‘Wrapper’ are different.
– A Pension wrapper allows a £40,000 annual contribution, when you make a contribution the government adds 25% as tax relief, it grows in a tax free environment, it can only be accessed from age 55 and when you take money out 25% is tax free and 75% is taxable.
– An ISA wrapper allows a £20,000 annual contribution, no tax relief is added when you make a contribution, it grows in a tax free environment, it can be accessed anytime and when you take money out there is no tax payable.
– A GIA wrapper allows any amount of contribution, no tax relief is added when you make a contribution, growth may be chargeable to Income Tax and/or Capital Gains Tax. it can be accessed at any time. You can choose capital units or income units depending on whether you prefer to receive income or gains so that when you take money out tax can be managed to some extent.
– An Investment Bond wrapper allows any amount of contribution, no tax relief is added when you make a contribution, there is no tax consequence for basic rate tax payers and a liability of 20% only for higher rate tax payers. Gains are taxed against your income tax rather than capital gains tax. 5% can be withdrawn per year with tax deferred for 20 years, Income tax can be managed by ‘assignment’ to a basic rate tax payer, it can be written into trust easily and used as an Inheritance tax planning vehicle allowing some greater control of assets.
It is therefore important to select the right wrapper first according to what you are trying to achieve and then to select the type of underlying investment that you want to have, you could therefore have a mixture of each type of wrapper, each with exactly the same underlying investment or each with a different underlying investment.
The main type of underlying investment are investment ‘funds’ which are ‘collective investment vehicles’ into which many people can buy into ‘collectively’. This allows easier access for individuals to invest in a greater number of different companies or assets and helps to ensure that your investment is well diversified, which should reduce risk.
There are many types of funds and each fund has rules which allow the ‘fund manager’ to invest in certain things and not to invest in other things, each fund will invest in perhaps about 100 different ‘companies’ or ‘assets’. Therefore, if you invest in one fund you will be invested in about 100 companies and if you invest in a second fund which invests in totally different assets then you will be invested in about 200 companies, which is a way of increasing diversification and giving proportions of your investments to experts who have a relatively narrow remit and a high level of understanding in their area of expertise.
Active Funds are run by a ‘manager’ who generally has a very narrow remit of what assets can be invested in and therefore should have a greater understanding of the specific area of expertise.
Multi Asset Funds are also active funds run by a manager but with a very wide ability to invest in many different types of assets, which means the fund manager must have a broader knowledge of all asset types.
Passive funds follow indexes like the FTSE 100 and therefore do not need a manager, because a computer can simply simulate the underlying assets held within the index.
We have portfolios for both active funds and passive funds (as well as Ethical Funds) and the cost is quite different between the two.
– Our Passive portfolios range from 0.15% to 0.20% per year (Approx. £150 to £200 per year per £100,000) and
– The Active Portfolios range from about 0.85% to 0.95% per year (Approx. £850 to £950 per year per £100,000).
In recent years the Active portfolios have outperformed the Passive portfolios by considerably more than the 0.7% difference (£700 per year per £100,000) and therefore you would have been much better off by investing in the more expensive funds than in the cheaper funds but of course we don’t know whether this will continue to be the case in the future.
Whilst the obvious argument for passive funds is that they are cheaper and that many fund managers don’t beat the general market anyway, the argument for active funds is that some fund managers do beat the general market considerably and also offer a less volatile investment experience – for example in 2008 the FTSE 100 fell 50% over a 3 week period whereas a well balanced portfolio of active funds only fell 20% during the same period and were back up again to where they started within a year….. whereas the FTSE 100 for example took much longer to recover.
Remember when you look at your investment it is no good assuming that you are going to be better off purely because the charges are low, if the performance would have been better by paying a higher charge – Equally if you are paying higher charges you should expect the performance to be better to make up for the additional cost. Each aspect is of significant importance and should always be compared.
Also it is important to remember that the costs of this kind of investing whichever way you choose are generally much lower than investing in most other kinds of investment. For example investing in property where you will pay interest on mortgages, pay deposits from taxed income, have void periods, repair costs, agency costs and potentially Capital Gains Tax are much higher, although the property may give just as good returns when taking the costs into consideration.
If you want a review of your investments or would like to understand more about how investments work; get in touch with our advisers to arrange an initial consultation.