In your best interest

April 15, 2014

You have spare cash. What’s the best way to invest it?

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If you’re reading this, it’s likely that you are in the top 5% of earners in the country. You might not feel it when it comes to shelling out a fiver on a pint in All Bar One, but statistically you are one of the rich ones.

Let’s assume you earn at least £60,000 per year: the starting salary for newly qualified lawyers in many bigger London firms. Once HMRC has taken their share, you might be left with about £3,000 per month. Say two thirds of this goes on living costs, bills and rent or mortgage.

Before you cry that £2,000 net a month isn’t enough to live on, bear in mind this is far more than the UK average monthly net income and we’re being pretty conservative with your salary figure here, so deal with it. Based on these numbers, you’re left with £1,000 each month in loose change.

What do you do with this money?

You could just stick it in a regular savings account and forget about it until you have enough for a house deposit, a new car or dinner at the Fat Duck. However, interest rates on savings accounts have been dismal for years now, so it may be worth considering other options out there. With a number of changes being implemented this year, here are three places you might want to stick your money until interest rates improve.

Individual Savings Accounts (ISAs)

If you don’t already have an ISA, stop reading this and go and open one now. Seriously, go now. They are a no-brainer, especially for those in higher tax brackets. The interest your money earns is tax-free and you are not liable for capital gains tax when you sell your investments (on a stocks and shares ISA – more below).

ISAs come in two forms: cash and stocks & shares. Before now, you could only put up to half your annual allowance into a cash ISA, with the rest in a stocks & shares version. This is set to change.

From April 2014, you are entitled to invest up to £11,880 in ISAs per year, with no more than half of this in cash. However, from 1 July 2014, ISAs get nicer and become NISAs (the acronym imaginatively stands for New Individual Savings Account).

The main changes are:

  • The annual limit will increase to £15,000.
  • There is no restriction on how you split your allowance: you could save all of it as cash, all as stocks & shares, or some combination of the two.
  • You will be allowed to convert stocks & shares to cash and vice versa: previously you could only convert one-way, from cash to stocks & shares.
  • Savings deposited with peer-to-peer lending schemes can be included in a NISA wrapper (see below).

Taking our monthly £1,000 loose change, you could stick all this in a cash ISA and be done with it. If you topped that monthly grand up a bit and used your full £15,000 annual allowance, you would save around £100 in tax (at an interest rate of 1.65% and as a higher rate tax payer), compared to a regular savings account. It won’t change the world, but it’s enough for a few drinks up The Shard, with minimal effort. Alternatively, why not consider a stocks and shares ISA?

Aren’t stocks & shares risky?

‘The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested’.

We’ve all heard these garbled warnings about investing in the stock market and it’s true, these beasts are inherently riskier than simple cash. However, with interest rates at an all-time low, you might want to look into this as an option, as the returns can be significant.

You can choose the level of risk you are willing to take, all within the ISA wrapper.

At the riskier end of things, you could look at investing in specific shares. While big established companies may appear a safe option, buying individual shares does mean all your eggs are in one basket. If the company fails, you lose your money.

The next level of risk would be actively managed unit trusts and investment trusts. These spread your money around, with the fund manager investing in a number of companies on your behalf. Theoretically, even if some of these companies don’t do so well, the rest of them hopefully will and the value of your overall investment should rise.

Finally, an option which is often recommended for beginners would be a tracker fund. These track the performance of a particular share index, and if this rises or falls, so will your investment. Returns may be lower than actively managed funds, but trackers are often considered to be lower risk so a safer bet for your hard earned cash. However, as always, returns are not guaranteed.

With all these options, you can make allowances for the natural bumps and lumps of the stock market (and so lessen your risk) by paying into a stocks and shares ISA/NISA ‘on the drip’, i.e. a little bit each month, rather than investing in a lump sum.

There is lots of advice online about starting out in these murky waters and it’s worth reading around the subject before taking the plunge.

Pensions

The rules about pensions are also due to change this year, although the most significant changes will affect those due to retire. The main change for those of working age is the reduction in the personal allowance (the amount of pension savings you can claim tax relief on) from £50,000 to £40,000 per year.

The prospect of tax relief means that pensions may be a good place to squirrel away some income, especially for higher rate tax payers. You can pay quite a chunk into your pension pot without noticing too much difference to what’s in your pocket.

Some experts suggest we should take the age at which we started paying into our pension and halve it to find out what percentage of our pre-tax salary should go into a pension. This means that someone who starts contributing at the age of 30 would be advised to pay in 15% of their pre-tax salary each month. At the very least, check you’re making the most of whatever your firm offers in the way of matched contributions.

Peer-to-peer lending

Peer-to-peer lenders have been cropping up everywhere over the last few years. They exist to connect lenders and borrowers directly, without the need for a bank, and in general, they offer higher interest rates on savings than banks or building societies. However, do read the small print to check how long your money will be tied up for.

As of April this year, these firms became regulated by the Financial Conduct Authority but be aware that your savings won’t be covered by the Financial Services Compensation Scheme (which covers a saver’s money up to £85,000 in the event that the bank or building society in which it is deposited goes bust). However, many peer-to-peer lenders have their own compensation fund, to protect savers in the event the worst happens, so it’s worth shopping around.

Three of the biggest are Zopa, Funding Circle and Ratesetter.

And finally

If all this sounds like too much effort, you could always try talking an independent financial advisor, who should be able to advise you on the best options for your situation.

Oh, and please note the usual disclaimer that none of the above constitutes financial advice and shouldn’t be relied on as such – what do you expect from a legal site? LM

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