Reader Question:
I’ve been made redundant and have £100,000 to invest. My mortgage is low and almost paid off so need to invest for an income boost. Do I buy a house or where else could I get decent return?
My response:
Essentially what you are asking is how to invest £100,000 to generate income now.
(Note: if you are investing for growth rather than income I’ve created a FREE short series of emails
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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? What is your attitude to risk? What is your investment timescale and do you need access to the capital?
If you don’t already have a reputable financial adviser who specialises in investments click here.
Whether you are investing for income or growth this is one of the best investment guides* I’ve come across. It takes you through the basics of understanding investing and your own risk profile (which is important). It also provides an excellent checklist of questions you should ask before you make an investment. Best of all it’s completely FREE.
But obviously I want to give you an idea of what your options are.
Property
On the assumption that you are looking to make income from your investment then buy-to-let is one option. As a nation we are obsessed with home ownership and as a result property is often seen as a safe investment. How many times have you heard the phrase as safe as houses or been told to invest in property?
Property returns do tend to be uncorrelated to investment markets but 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.
For a buy-to-let investor concerned with rental income, the average UK property yield is around 5% gross (i.e. before tax) but there are massive regional variations. Buy-to-let 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.
Cash
Although a lot of people think of cash as the starting place when looking to invest it can be the eventual destination. If you really want to ensure you get the best interest rate for £100,000 or more of savings then I would highly recommend reading through the following guide – The biggest mistake made by larger savers*. It’s FREE and provides advice on common mistakes to avoid and how to get the maximum interest and protection on your savings.
If you would rather go it alone then you need to realise that 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. NS&I Index Linked Savings Certificates offer a risk free and tax free way of beating inflation, as measured by the Retail Prices Index or RPI. So what are the alternatives now?
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. Here is a roundup of the current best savings rates available on instant access accounts. Even these rate usually fall woefully short of inflation. There are also a number of 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. Theses 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 in the medium term the Bank of England Base Rate (which influences rates on savings and mortgages) start to return to normal (which is around 5%) then you could find yourself stuck with a deal which isn’t as competitive as rates offered on ordinary savings accounts. Something to think about.
One of the best FREE tools out there is the rate tracker email alert*. You simply enter your email address and the details of the savings accounts you currently have (there are no security issues as I’ve been happily using it for over 18 months). Then not only will the system tell you if you are getting a good deal but it will continuously monitor the market for you and email you when there are better deals out there than your existing account. Make sure you put in the current balance for each of your savings account. 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. 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.
Peer-to-Peer lending (the savings account alternative)
If the interest available on cash is unexciting enough for you then one way to get a better rate is through peer-to-peer lending. When savers deposit money in a normal savings account the bank can and does lend that money to other people in the form of loans. The profits that the bank makes help pay the interest you earn on your savings account. Peer-to-peer lenders cut out the middle man (the bank) and allow you to lend your money to borrowers directly in return for a higher rate of interest. The way this works is that when you deposit your money the peer-to-peer lender will parcel it up into smaller loans to manage risk (much like a bank). The reason why you get a much better interest rate is because without the middle man (the bank) you keep more of the profits as there are no bank branches etc to pay for. The best peet-to-peer lending rate you can get is around 5% before tax.
At present use of a peer-to-peer lender is not covered by the Financial Services Compensation Scheme. Yet the industry is gaining growing support from the UK Government with announcement that the first £1,000 of interest from peer-to-peer lending will be tax free for a basic rate tax payer from April 2016, in line with ordinary savings accounts. Peer-to-peer lending is now seen as a viable alternative to savings accounts with UK savers lending over £600million to date.
Zopa* is the largest and peer-to-peer lender in the Europe (with 500,000 customers) and has the best track record of managing risk among any UK bank or peer-to-peer lender. You can earn up to 5% on your money and Zopa* has been named the best peer-to-peer lender by numerous industry consumer bodies.
Equities
It is possible to invest directly in shares and hopefully receive an 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 receive tax- free, or at least in part) . Well that’s the theory. 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). According to the Barclays Equity Gilt Study equities have produced an annual return of around 5.4% over the last 50 years but this does mask huge crashes and market rallies.
Bonds
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.
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.
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 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 into a number of investment funds which invest in a range of assets.
WRAPPER/PRODUCT
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.
In terms of making money, perhaps the most important consideration to get right is choosing the best petrol i.e. picking the right underlying investments/assets. But rather than buy the aforementioned assets directly it is often preferable to invest in funds (also called collective investments) via one of the wrappers (investment vehicles) that I will come on to.Funds work by pooling investors money together so they benefit from economies of scale as well as the ability to change their investments easily. Understanding how investing in funds works is simpler than it sounds. As part of my drive to empower everyone, I source the best FREE guides out there designed to teach you how to become successful DIY investors.Therefore I suggest that you download this FREE guide to investing in funds*. It is the best guide I’ve found on the topic and covers everything including how to get started with buying funds.
So what about the investment wrapper, i.e the car in my analogy above? 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)
This is effectively buying funds outside of any investment wrapper. These are pooled funds where lots of investors’ money is combined and the fund run by an investment manager with a certain brief. This can be based on the asset type such as bonds, property, shares, a geographical region or a theme such as cautious managed. 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
Stocks and Shares ISA
This is simply a tax wrapper and can hold cash, shares and collective investments 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 which is currently £15,000.
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.
Building a Portfolio (and a useful guide)
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. 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.
But I don’t want to completely sit on the fence. While I don’t know your personal circumstances someone looking to build an investment portfolio (through whatever wrapper) to generate income would likely have Equity Income Funds and Bond Funds at its core (average current yield on an equity income fund is about 4%). But in both these cases don’t just be lured by an attractive yield figure of a given fund. Without exception higher yield means higher risk and normally the greater chance of capital loss. For a pure income seeking investor a short term capital loss is not a problem, as long as they still receive the regular income/dividends, and they do not need to crystalise the capital loss. To download a useful guide on equity income funds click here*. Interestingly there are some property income funds have recently been launched.
Annuity
If you simply want income and no access to capital then it is possible to buy an annuity which will provide you with a guaranteed income stream. The level of income will depend on your age and possibly health but once purchased you lose all access to the capital.
Conclusion
So is property the best way to provide income? Not necessarily and in my opinion I’d be wary of putting all my eggs in one basket. Buy-to-let yields vary wildly and the costs involved are often unforeseen.
Diversifying the assets you invest in not only reduces risk but also diversifies the source of your income. The greater the investment risk you take the greater the potential loss. Can you afford to lose any money? If not then you may need to be realistic with your income targets for any investment and settle for safer assets.
As I’ve said seek financial advice as an adviser will be able to advise you on the best thing to do with the £100,000 which may not even be to invest it, once your wider circumstances have been taken into account.
I hope that helps
Best Wishes
Damien
Money to the Masses
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