Investors have been given an “Isa season” boost as markets have shrugged off Britain’s credit rating downgrade to continue their bold start to the year.
Danger could yet lie in wait for investors, however. The recent market rally has taken place in spite of poor economic indicators and there are many events over the next few months with the potential to test the market’s resolve.
As the end of the tax year approaches and investors look to use their annual individual savings account (Isa) allowances, there are some tricky choices to make.
Investors can shelter up to £11,280 in a stock and shares Isa on or before 5 April, half of which can go into a cash Isa. That limit rises to £11,520 on 6 April (up to £5,760 in cash), as attention turns to next year’s Isa allocation.
But whatever happens to the stock market or global economy in that time, there are four simple steps that will stand investors in good stead. Read on to find out what they are.
• Start with a vision
Some UK investors have collected Isa products like a collector would collect teapots. Not that collecting Isas is a bad thing – far from it. Even an eclectic collection of the maximum possible allowance of Isas and its predecessor, personal equity plans (Peps), from 1987 through to 2012, could have amassed a pot worth £500,000 today with a bit of luck.
Take luck out of it, apply sound investment principles and gather equity returns 50 per cent from the UK and 50 per cent from the rest of the world in the same time period and you get to a figure of £575,100.
So think big! Anybody starting now could build up a £250,000 pot in ten to 20 years’ time. All you need is the vision. For example, “I am going to buy a £150,000 boat when I stop working” or “We are going to build up a £250,000 university fund for our daughters by the time they leave secondary school”, and crucially the determination to follow it.
• Create an Isa shed
Think of your overall Isa plan as being a big, secure shed in which to keep your investments. All you have to do is unlock the door, put money into your shed every month and lock the door again. You will probably own this shed for the rest of your life.
Plan to set aside a certain sum every month for as long as it takes, until you have built up £250,000. You will definitely reach your target eventually, provided you stick to the plan.
There’s no need to wait until this time next year until you use your 2013-14 Isa allowance of £11,520. You can start to invest this from 6 April and could stash away monthly sums of £960 over the next 12 months.
Gathering healthy investment returns along the way will get you there sooner. Keeping all the returns and not giving any away to the taxman will get you there even sooner – and that is the beauty of putting those monthly savings into an Isa – all gains are completely tax-free.
So when you break into the pot for school fees or for life after work you will not have to fork out part of your gains on tax.
• Use an investment craftsman
Put a little guy in your shed and leave him to use his tools. This could be you, a fund manager or an independent financial planner.
The little guy is smart, but not too smart for his own good or yours. He is a master craftsman and will not rely on luck to achieve your target. Rather, he will use his tried and tested tools and his skill and judgment.
In the first five years or so he will use his favourite tool – pound cost averaging. Each month he will allocate the pounds you have taken to your shed between no more than, say, three investments.
He will purchase the same monetary amount in the same three investments every month for, say, 60 months.
This way, he intelligently makes market volatility your friend, ensuring that your average actual unit price paid over five years will be less than the average quoted price over the same period.
The little guy also uses an anti-inflation tool. The last thing he wants is for you to open up your shed in 20 years’ time and be thrilled to find a huge amount of pounds, but very disappointed to find that your pounds have lost their purchasing power and you are unable to meet your target.
He has reference books at his disposal. These books contain data on all asset classes going back 50 years showing their long-term total returns from income and gains and to what extent in percentage terms compound returns have exceeded compound inflation. He knows how to blend asset classes in a way that will maintain focus on returns but minimise the effect of downside movement in a particular asset class.
This way, he will keep you incentivised to keep to your side of the deal – putting money in your shed every month.
He is canny: he will not trade the contents of your shed day in, day out because that costs money, eats into returns and could destroy your plans. Instead, he will apply the new money you add each month to assets which he feels are temporarily depressed and, therefore, represent long-term value. He will keep buying those until he judges you have enough.
• Be disciplined
The sums that some investors have built up in tax-privileged savings speak volumes about investor discipline – purchasing a Pep or an Isa at every opportunity since they were introduced in 1987, irrespective of whether financial markets were buoyant or in a slump at the time. Don’t be promiscuous and have a succession of Isa one-night stands. Rather, see a potentially rewarding relationship that will last a lifetime. Isa portfolios can also be used as part of an efficient inheritance tax planning strategy. Send me a postcard when you reach £250,000 because, believe me, you will get there.
• Sandy Robertson is a certified financial planner and managing director of Acumen Financial Planning.