Lump Sum Investment 1857037421, 9781857037425

Table of contents :
Contents......Page 6
List of illustrations......Page 9
Preface......Page 10
Checking your financial health......Page 12
Saving to invest......Page 15
Understanding the theory of money......Page 19
Grasping the language of investment......Page 21
How stock exchanges work......Page 27
Choosing an investment category......Page 30
Interpreting company reports......Page 31
Monitoring your investments......Page 33
Making bank/building society deposits......Page 36
Investing in National Savings......Page 38
Buying gilts......Page 43
Understanding bonds......Page 46
The Savings Gateway......Page 48
Selecting investment trusts......Page 51
Investing in unit trusts......Page 52
Comparing investment trusts and unit trusts......Page 53
Choosing index trackers......Page 54
Buying insurance bonds......Page 55
Building up an equity portfolio......Page 63
Day trading......Page 66
CFD trading......Page 67
Investing in employee share incentive/option schemes......Page 68
Investing through an investment club......Page 72
Getting shareholders' perks......Page 73
Buying convertibles......Page 75
Backing films......Page 76
Investing in futures and options......Page 77
Using offshore funds......Page 78
How split funds work......Page 79
Betting on financial spreads......Page 81
Buying warrants......Page 82
Choosing individual savings accounts......Page 85
Keeping up your personal equity plans......Page 90
Dealing with your tax-exempt special savings account......Page 91
Accumulating an emergency fund......Page 93
Retirement planning......Page 94
Financing your children's education......Page 96
Dealing with your mortgage......Page 97
Buying annuities......Page 100
Investing for children......Page 101
Investing by the elderly......Page 104
Investing in property......Page 105
Collecting......Page 108
Making the most of redundancy pay......Page 110
Attacking your investment income tax bill......Page 113
Minimising capital gains tax......Page 115
Avoiding inheritance tax......Page 121
Investing as a non-taxpayer......Page 126
A: General reading, listening, viewing and surfing......Page 129
B: How to get further information and advice......Page 131
C: How to complain......Page 134
B......Page 136
E......Page 137
H......Page 138
N......Page 139
R......Page 140
T......Page 141
Y......Page 142
E......Page 143
P......Page 144
Z......Page 145

Citation preview

Lump Sum Investment

Books to change your life and work. Accessible, easy to read and easy to act on Other titles in the How To series include: Paying Less Tax How to keep more of your money for saving and investing Personal Finance on the Net Use the power of the Internet to grow your personal wealth Making Your Money Work for You How to use simple investment principles to increase your wealth Managing Your Personal Finances How to achieve your own financial security, wealth and independence Starting Your Own Business How to plan and build a successful enterprise

Send for a free copy of the latest catalogue to: How To Books Spring Hill House, Spring Hill Road Begbroke, Oxford, 0X5 1RX, United Kingdom email: [email protected] http://www.howtobooks.co.uk

Lump Sum Investment Assess your needs; explore the opportunities; maximise your investment

JOHN CLAXTON

How To Books

To Ann and Alan

Published by How To Content, A division of How To Books Ltd, Spring Hill House, Spring Hill Road, Begbroke, Oxford 0X5 1RX. United Kingdom. Tel: (01865) 375794. Fax: (01865) 379162. email: [email protected] http://www.howtobooks.co.uk All rights reserved. No part of this work may be reproduced or stored in an information retrieval system (other than for purposes of review) without the express permission of the publisher in writing. The right of John Claxton to be identified as the author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988. © Copyright 2002 John Claxton First published in paperback 2002 First published in electronic form 2007 ISBN: 978 1 84803 072 5 Cover design by Baseline Arts Ltd, Oxford, UK Produced for How To Books by Deer Park Productions, Tavistock, Devon, UK Typeset by Kestrel Data, Exeter, UK NOTE: The material contained in this book is set out in good faith for general guidance and no liability can be accepted for loss or expense incurred as a result of relying in particular circumstances on statements made in the book. The laws and regulations are complex and liable to change, and readers should check the current position with the relevant authorities before making personal arrangements.

Contents List of illustrations

8

Preface

9

1 Preliminaries Checking your financial health Saving to invest

11 11 14

2 Becoming Your Own Financial Adviser Understanding the theory of money Grasping the language of investment How stock exchanges work Choosing an investment category Interpreting company reports Monitoring your investments

18 18 20 26 29 30 32

3 Fixed-Interest Investing Making bank/building society deposits Investing in National Savings Buying gilts Understanding bonds Permanent interest-bearing shares The Savings Gateway

35 35 37 42 45 47 47

4 Investing in Pooled Equity Funds Selecting investment trusts Investing in unit trusts Comparing investment trusts and unit trusts Choosing index trackers Investing in friendly society savings schemes Buying insurance bonds

50 50 51 52 53 54 54

5

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5 Direct Investing in Equities Building up an equity portfolio Day trading CFD trading Investing in employee share incentive/option schemes Buying shares in your employing company Investing through an investment club Getting shareholders' perks

62 62 65 66 67 71 71 72

6 Making Riskier Investments Commercial forestry holdings Investing in commodities Buying convertibles Understanding EISs and VCTs Backing films Investing in futures and options Becoming a Lloyd's name Using offshore funds Buying penny shares How split funds work Betting on financial spreads Buying warrants

74 74 74 74 75 75 76 77 77 78 78 80 81

7 Understanding ISAs, PEPs and TESSAs Choosing individual savings accounts Keeping up your personal equity plans Dealing with your tax-exempt special savings account

84 84 89

8 Investing for Financial Health Accumulating an emergency fund Retirement planning Providing for special events Financing your children's education Dealing with your mortgage

92 92 93 95 95 96

9 Specialised Investing Buying annuities

99 99

90

Contents

Investing for children Making ethical investments Investing by the elderly Investing in property Collecting Making the most of redundancy pay

7

100 103 103 104 107 109

10 Reducing Tax on Investments Attacking your investment income tax bill Minimising capital gains tax Avoiding inheritance tax Tax-efficient investing Investing as a non-taxpayer

112 112 114 120 125 125

Appendices A General reading, listening, viewing and surfing B How to get further information and advice C How to complain

128 128 130 133

Glossary

135

Index

142

List of Illustrations 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

How to prepare a weekly or monthly budget The time value of money How savings can grow in different investments The breakeven points for 22% and 40% taxpayers Comparison of growth of fixed interest and equity Comparison of income from fixed income and equity How to calculate the value of rights Current National Savings interest rates CAT standards for ISAs Relationship of ISA and PEP charges to tax savings The added benefits of a PEP over direct investment in unit trusts Examples of annuity rates Current income tax data Capital gains tax taper relief The new method of calculating the chargeable capital gain Example of a taxable capital gains calculation Lifetime transfers exempt from inheritance tax Example of how immediately chargeable transfers, potentially exempt transfers and IHT taper relief work

8

12 18 19 20 22 22 25 38 86 88 88 101 112 116 118 119 122 123

Preface Wouldn't it be great to win the pools or the lottery? Even a small amount would be very welcome. Have you inherited some money, or received a juicy year-end bonus? Or maybe you have been thrifty and have made savings out of your income? It you have a lump sum that you intend to spend on a holiday or a new car, it could be earning you a return rather than just sitting in your current account waiting to be spent. Do you know how to make sure it does? You may decide to keep some of it, perhaps for a rainy day or to improve your retirement income. If this is the case, you'll need to make decisions about how to invest it. This book takes you through the investment maze, explaining each category of investment in simple terms, avoiding jargon, or at least explaining it. The first chapter will show you how to check your financial health in order to make the best use of your money. The second chapter helps you to become your own investment adviser, although you should consider seeking professional advice if you are still in doubt. The following chapters deal with specific investment possibilities. If there is a particular area of investment you wish to know more about and do not see it in the chapter headings and sub-headings at the front, try the index at the back. I wish you profitable investing! John Claxton

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1 Preliminaries CHECKING YOUR FINANCIAL HEALTH Before embarking on investing a lump sum it is advisable to check your financial health, to see how you measure up to the ideal. Preparing background information If you consult a financial adviser, you will first be asked for some background information. Here you are the adviser as well as the client so, although much of this information will be obvious to you, it is still worth writing it down as it will affect what comes later. Personal profile A financial adviser will ask: your age; whether you are employed, self-employed, unemployed or retired; whether you are married, have children still dependent on you (or any other dependants, such as a widowed mother without much pension); and what is your highest income tax rate (your marginal rate). Budgeting If you do not have a clear idea of your weekly or monthly income and expenditure prepare a budget on the lines of Figure 1. Include in it any savings you are making for a specific event.

11

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Income Pay (after tax) Investment income Other (eg benefits) Total

Expenditure Home costs

-

mortgage repayment council tax home & contents insurance electricity and gas telephone water repairs

Living costs

-

food & drink clothing TV rental and licence social and sports

Travel

- bus/rail - car - loan repayment - petrol - insurance - repairs and service - duty and MOT

Financial

-

Special events

- birthdays - holidays - Christmas

life assurance pension contributions credit card interest loan/overdraft interest

Other Total

Fig. 1. How to prepare a weekly or monthly budget.

Preliminaries

13

Your financial assets and liabilities List any savings and investments you have, followed by a list of any liabilities - bank overdraft, credit card debt, etc. The difference between the two is the value of your net current assets (if it is a negative amount, you need to plan to reduce your debt). Your mortgage is a separate issue because it is a long-term liability. Doing your financial health check The ten steps which follow are in order of priority. /. Reducing borrowing Are you borrowing money, except against your home? If so, consider paying it off as soon as possible as the interest will be expensive. 2. Establishing an emergency fund Have you got a cash reserve to fall back on - at least one month's normal expenditure and preferably two or three, in an instant-access deposit account or as a borrowing facility? At least half the population has less than £1,000 readily available and 10% have nothing at all. (See Chapter 8 for information about accumulating an emergency fund.) 3. Avoiding financial disaster Is your income protected by insurance against the death, sickness or permanent disability of the breadwinner? Do you have adequate home and car insurance? 4. Retirement planning Are you paying towards a pension? It is never too early nor too late to start. (See Chapter 8 for retirement planning.) 5. Getting tax and social security advantages Are you getting all the income tax allowances, reliefs and credits, and social security benefits you are entitled to?

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6. Estate planning Will your heirs have to pay inheritance tax? If so, consider how to avoid it or pay for it yourself. (See Chapter 10 for inheritance tax.) 7. Saving for special events Do you need to save up for - your next holiday, a new car, a wedding, long-term care in old age? Putting aside just a small amount regularly is the best way. (Chapter 8 gives more information about providing for special events.) 8. Paying for education If you have young children, are you saving up to pay for private education and/or university? (See Chapter 8 for financing your children's education.) 9. Reducing your mortgage It is worth considering a reduction before investing surplus income or a lump sum. (Chapter 8 also gives more information on this.) 10. Investment planning Have you surplus income which can be channelled into a savings scheme or do you have a lump sum to invest? Making strategic decisions

The result of your financial health check may cause you to change your budget, for example to pay for more insurance cover. Or you may wish to change your existing savings and investments to fit in with the ideal - perhaps to put more into your cash reserve. Make a list of your shortcomings compared with the ideal and decide what action to take. SAVING TO INVEST

If you do not have a lump sum to invest but can afford to

Preliminaries

15

save, there are many investment products which accept regular monthly payments. In other cases, where the minimum investment is low and monthly savings are high enough, they can be invested directly. For example, National Savings certificates have a minimum of £100. Otherwise, savings can be put into deposit accounts until enough has been accumulated to make a lump sum investment. The advantage of investing regular savings is that there need be no commitment to maintaining payments, e.g. there is no harm done by missing a monthly purchase of a savings certificate. Analysing your savings needs If you need or wish to save, consider the following: What are you saving for - to increase your cash reserve, for a special event, for your children's education, for retirement - and how much do you need? If you have more than one reason, decide the priority. How much can you save, each week or month, and so how long will it take to achieve your objective? Do you need quick access to the money? Bear in mind that, if not, you might get a higher return from a longer-notice deposit account, or even in an equity investment, which should grow more in the long run (say at least five years). Do you pay tax and if so what is your marginal rate? Compare returns on an after-tax basis. Can you save regularly? It is better if you can, but be wary of committing yourself to a regular savings contract if there is a penalty for missing a payment. Irregular deposits when you can afford them are better than nothing.

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Is your priority income or capital growth? Some investments are better for one, some for the other, but many achieve both. How much risk are you prepared to take? Higher risk should lead to higher returns but only in the longer term. Risk is dealt with in more detail in Chapter 2 under 'Grasping the language of investment'. CASE SCENARIOS Amanda Amanda works for a Lloyds insurance broker. She is an independent young woman, a high earner and a high spender. She rents an expensive flat in central London. She does not have a regular boyfriend, but she would like to have a family in the future. Most years she gets a big year-end bonus. Her financial health check shows no need for a recognised emergency fund, as she has plenty of cash in her bank account, and she has adequate insurance but no provision for a pension. Amanda realises that she should look to the future and start taking action. She can easily afford to direct some of her earnings to a pension scheme. Alistair and Jean Alistair and Jean live together, having both been divorced. She has custody of her two children from her first marriage and they have a baby of their own. Alistair is a civil servant. Jean does part-time secretarial work at home. They own their own home, with a £50,000 mortgage. They have recently inherited a lump sum from Alistair's parents. Their financial health check shows they have an adequate cash reserve and pension provision but are not covered for the loss of family income should Alistair become unable to work through a serious illness. They think about permanent health insurance.

Preliminaries 17

Gwen and Hugh Hugh is a welder in a metal-bashing factory. He is nearing retirement age. Gwen has never worked since marriage; she has been too busy bringing up their three children, who have all now left home and are self-sufficient. There is one grandchild so far. They live in a council house which they bought from the council some years ago. Hugh can take a tax-free lump sum from his company pension scheme when he retires. The financial health check shows good coverage for pension and insurance but an inadequate cash reserve. They decide to build it up as soon as possible as a matter of priority, by adding to the small amount they already have in a building society. POINTS TO CONSIDER FURTHER

1. If you are borrowing money (other than a mortgage) and you have a cash reserve, should you use the reserve to reduce the borrowing? What could replace the reserve fund? 2. Is your mortgage sufficiently flexible to allow you to pay some off early without penalty? If so, what priority does this have on your list for using a lump sum? 3. If you are saving out of income to build up a lump sum for investment, where do you propose to put the money meanwhile in order to make it work for you?

2 Becoming Your Own Financial Adviser UNDERSTANDING THE THEORY OF MONEY The time value of money

When lending (and borrowing) money, the timing of payments of interest and return of capital has a significant effect on the interest rate. For interest receipts it is called the AER (annual equivalent rate). In the case of interest payments, such as for a mortgage, it is called the APR (annual percentage rate) but is effectively the same thing. Figure 2 provides an example of the time value of money. When VAT on fuel was introduced in 1994, many people paid in advance to save the 8% tax. Decisions like this should consider the effective rate of return on the investment for the period. Assuming your annual fuel bill is £100, what is the effective rate of return? On the face of it, you might say 8%, because that is what you have saved. However, taking account of the time value of money, you need to allow for the fact that normally you pay monthly or quarterly. So, ignoring seasonal variations, you would have only paid 7Vz months in advance on average. Consequently the effective AER (annual equivalent rate) of 8% over 7Vz months is 13%. Bearing in mind that it was effectively after tax, this was easily the best investment in 1994. Fig. 2. The time value of money

18

Becoming Your Own Financial Adviser 19

The effect of compound interest Compound interest arises where interest is left in an investment and itself then earns interest. For example, doubling your money in such an investment takes: ten years at an interest rate of 5% seven years at 10% only five years at 15%. Another example comes from pensions. To achieve a pension of £10,000 a year from the age of 65, a man needs to contribute: starting at age 30, £150 a month starting at 40, £300 a month starting at 50, £600 a month.

Fig. 3. How savings can grow in different investments. (Source: Hindsight from HSW, Micropal.)

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(For a woman it is 10% more in each case.) Figure 3 shows how savings can grow in different investments. The effect of inflation

'Real' rates of interest are the rates in excess of inflation. Only these rates preserve the real value of the capital. Usually they are in the region of 3%, whatever the actual rate. However, since all interest is taxable, high interest rates can result in negative real rates, so they are not necessarily a good thing for taxpayers. Figure 4 shows the breakeven points for 22% and 40% taxpayers.

Table of after-tax real rates of interest (i.e. rates after allowing for inflation), assuming a pre-tax real rate of 3%. Note the breakeven point for inflation protection, at 20% and 40%. Net of 20% tax

Rate of inflation

% 2 4.5 7 12

Total interest

% 5 7.5 10 15

Net of 40% tax

Total return

Real return + or -

Total return

%

% +2

% 3

+1.5

4.5 6 9

4 6 8 12

+1 -

Real return + or % +1 -1 -3

Fig. 4. The breakeven points for 22% and 40% taxpayers.

GRASPING THE LANGUAGE OF INVESTMENT Fixed interest investments

These are investments where the income is a fixed amount, at least for the time being. Usually the capital value is also

Becoming Your Own Financial Adviser 21

fixed, although in some cases it can change, too. However, either income or capital are fixed and in many cases both. Equities These are investments in ordinary shares of companies, where both the income and the capital can vary up or down. They can be bought and sold on a stock exchange and they participate in profits (after any preference dividend is paid) and receive dividends, usually paid half-yearly. Shares have a par value - usually £1 or 50p - but this bears no relationship to their market value and can be ignored. Fixed interest versus equities All statistics show that in the long run, due to capital growth, equities beat fixed interest by a big margin, whereas fixed interest may not even beat inflation (see Figure 5). Here is another comparison. If you invested £1,000 in 1973, 20 years later, in 1993, it would have grown to: building society (average) . £43,000 shares (FTSE 100)

£297,000

Even after allowing for inflation, the equity investment would have risen to £56,000, whereas the building society would not have kept pace with inflation and would have fallen to £8,700. Although the income on equities is less than on fixed interest to start with, it catches up and passes it in the long run. Over the past 30 years or so, income from equities has on average doubled every seven years (see Figure 6). But to achieve the best returns on equities it is necessary to have flexibility in the timing of both buying and selling and an ability to remain invested for the long term - say five years at least.

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Fig. 5. Comparison of growth of fixed interest and equity.

Fig. 6. Comparison of income from fixed income and equity.

Becoming Your Own Financial Adviser 23

Active versus passive equity investing Active investing is where you choose a manager or invest directly in equities (including pooled equity investments see Chapter 4) in the expectation that you can beat the market index. Passive investing is where you invest in an index-tracking unit trust (see Chapter 4) so that you track the market. Risk The more you have invested and the longer you can leave it alone, the more risk you can afford to take with some of it to achieve a higher reward. The most important thing is to recognise the existence of risk and to take appropriate steps. Spread your investments over a number of different categories, having perhaps more than one investment in each category. Consider pooled investments such as unit trusts (see Chapter 4). In this connection, some advisers suggest that you should take into account your income from earnings (or from your pension if you are retired), which they capitalise and call your lifetime capital. The relative steadiness of this income can mean that you can take more risk with your investments. Always look at the downside risk of each investment and decide whether you are happy with it. However, to achieve higher returns in the long run, you need to take some risk. Shares have three opportunities/risks: the individual company, the market sector (such as stores, banks); and the overall market. The volatility of individual shares has increased significantly in recent years and the potential to lose money is something like three times as great as 30-40 years ago. This applies in particular to shares in the FTSE 100 index (smaller companies are less volatile). In very recent

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times this increased volatility is due to the Internet-linked companies. Events in the lifecycle of shares

New issues New shares sometimes come to the market as a result of de-nationalisation and de-mutualisation but any company coming to the market for the first time is a new issue. Application forms are printed in newspapers and are available on request. You fill in the form and send it off with a cheque. You may not get all the shares you ask for. Some people apply for more than they expect to get. Stags are people who aim for a quick profit, applying for a large number of shares with the intention of selling them as soon as they are received. There is no commission or stamp duty payable on new issues and the full amount may be payable in instalments. Rights issues This is where a company raises further capital by offering existing shareholders the right to apply for more shares. The price is usually set below the current market price so that the rights themselves have a market value. Shareholders can decide whether to take up their rights, so investing more money in the company, or to sell them. Those taking no action usually have the rights sold for them. There is a third way, called tail swallowing, which is particularly appropriate if your investment is in a PEP or ISA. If you wish to take up the rights but have insufficient cash in the account, you can sell enough rights to bring your cash available up to the amount required for the remaining rights. See Figure 7 for an example of how to calculate the value of rights.

Becoming Your Own Financial Adviser 25

Assumptions Present market price of share - 200p Rights issue - 1 new share for every 5 held, at 150p per share Calculation Excess of market price over rights price = 200 - 150 = 50p Divide that by the number of old shares for each new one Value of rights = 50/5 = 10p each What will the share price be after the new issue (assuming no other change)? 5 existing shares at 200p = 1,000p 1 new share at 150p = 150p Total - 6 shares

1,150p = 191p per share

Fig. 7. How to calculate the value of rights. Bonus issues This is a misnomer - there is no bonus! A better term is scrip issues (or capitalisation issues) and it is where existing shares are subdivided into, say, two new shares, thus doubling the number of shares and halving their value. No new money passes, the action being taken usually because the share price has risen to a level which is considered too high for an effective market. Scrip dividends This is where companies offer shareholders the opportunity to take new shares instead of a cash dividend. It is a cheap way to invest more money in a company but it complicates capital gains tax calculations. Share buy-backs A company sometimes buys back shares, usually because it has surplus cash which cannot be invested more profitably elsewhere. The effect should be an increase in the share price.

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Take-over bids From time to time one company will attempt to take over another by offering an attractive price for the shares. It is worth waiting for a competitive offer, even if the directors recommend acceptance. Newspapers and investment magazines will comment on the offer. If the buying company is successful it can force the purchase against reluctant sellers. Receivership and liquidation If a company fails to pay debts a lender of money to it can appoint a receiver to manage its affairs (or have one appointed by the creditors) or the company can be put into liquidation. In either case, it is unlikely that the equity shareholders will get much, if anything - they are at the end of the queue. HOW STOCK EXCHANGES WORK

The London Stock Exchange is a marketplace for buying and selling shares. There are two groups: Stockbrokers, who buy and sell for you. They arrange the deal and receive commission, which might be 1 % with a minimum amount of perhaps £15. Market makers, who buy from and sell to you. They get the difference between the buying and selling price the spread (this is usually about 1%). There is a new trading system, called order-driven trading (the old system is called quote-driven trading), operating for high value companies - SETS (Stock Exchange Electronic Trading System) - whereby buyers and sellers are automatically matched. However, deals are still set up by stockbrokers. Some large companies have set up means to trade in their shares at lower costs than are charged direct by stockbrokers.

Becoming Your Own Financial Adviser 27

In addition to commission, stamp duty of 0.5% is payable on purchases. Adding these together and you have to achieve a gain of about 2.5% to break even. The animals The Stock Exchange is full of nicknames. You have already met stags but there are two more important animals - bulls and bears. Bulls are optimistic and believe share prices will rise; bears take the opposite view. To go with the meat there are chips! Blue chips are shares in big companies thought to be relatively sound, such as BP Amoco and Tesco. Then there are white chips smaller, sound companies. Share prices Prices of popular shares are printed in most daily and evening papers and can be found on Ceefax/Teletext and on the Internet. They are usually grouped into sectors, such as stores, electrical, engineering. Lists of share prices will include some or all of the following: Yesterday's closing price - this being the middle market price, halfway between the buying and selling prices. Yesterday's increase/decrease, shown as + or - the previous day's price. Highest and lowest prices in the last 52 weeks. Market capitalisation - total number of shares times current price, a measure of company size. Gross yield - last full year's dividend before tax as a percentage of the current price. P/E ratio - price divided by earnings (profit before tax) per share, i.e. how many years' earnings to recover the share price (theoretically the higher the figure the better the potential growth).

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Share price indices

Most people have heard of the 'footsie'. It is the FT/SE (Financial Times/Stock Exchange) 100 index - the 100 being the largest 100 companies by market capitalisation. The other main index is the all-share index comprising all the shares quoted on the main exchange. There is also the mid 250, being the next 250 after the top 100, and the recently introduced Techmark index for new technology stocks. There are also indices for the main categories of shares on the London market and for foreign shares - Europe, the US, Japan, the Far East. Settlement

Most transactions are now settled electronically through the Crest system, under which share ownership is registered in the name of a nominee. The old system using transfer forms and share certificates is still available but may cost more. Settlement of electronic deals is now made three working days after the transaction date. For certificated dealing it is still ten days. Alternative investment market

In addition to the main market, there is also AIM - the alternative investment market - which deals in shares of companies which are relatively new and small. It is an intermediate step before the main market. Stock exchange regulations are less onerous than for the main market, but this does not in itself mean more risk for the investor. Shares quoted on AIM are more volatile, may be difficult to buy and sell due to restricted numbers and are certainly more risky due to the newness and small size of the companies. However, large profits can be made. OFEX market

This is a market for trading in shares in unquoted companies, that is companies which are not quoted on

Becoming Your Own Financial Adviser

29

the main or AIM markets and are therefore much more risky. Stockbrokers Some operate on an execution-only basis whereby they just deal in accordance with instructions. If advice is also needed, it will cost more. Deals are usually arranged by telephone or using the Internet. The cheapest execution-only brokers have a minimum charge of not much over £10, with 1% thereafter. A list of execution-only brokers can be obtained by ringing (020) 7247 7080. CHOOSING AN INVESTMENT CATEGORY The issues to consider are: Do you want protection against inflation? Remember that equities stand a better chance of achieving growth in the long run but index-linked products can be considered for fixed-interest investing. Do you want income? Income-producing equity investments can achieve growth as well but there is no point buying a product which must pay out income when you would rather it were left in. Can you afford to take risks? Questions to ask about any investment Capital - does it remain unchanged or can it go up and down? Income - is it fixed or variable? - is it paid out, kept in or reinvested? Tax - is income tax-free, taxable or taxed? - are capital gains taxable? Guarantees of income or capital - are there any?

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Period of investment - is it fixed or variable? Risks to capital or income - what are they? Commission - is any payable and to whom? Management fees - how much, if any, initial and/or annual? Past performance - what is it, remembering that it may not be maintained? Future performance - what could affect it? Warnings Beware of the hard sell. Beware of apparent bargains. Beware of fashions. Read the small print, especially if there are guarantees. Consider the implications of long-term commitment, especially for regular contributions. INTERPRETING COMPANY REPORTS If you invest directly in shares, you should receive copies of company reports unless the shares are held by a nominee. If you are thinking of investing in a company and would like to see the annual report, you can arrange to have it sent to you (ring the company secretary). If you do not receive company reports because your shares are held by a nominee, you can arrange to get them. To avoid additional cost, a useful source is the Financial Times, which has a free service - see the notes on the share price pages. Annual report and accounts This is usually a glossy affair which the company uses for publicity and marketing. It is also long and wordy because parts are required by law.

Becoming Your Own Financial Adviser 31

To find out what really matters without reading it all, consider the following: Summary Read this first. It will be at or near the beginning and may be called 'Financial Highlights'. Compare this year's figures with last year's. Look especially at earnings per share (EPS) as this is the most valuable statistic. EPS is profit for the period divided by the number of shares in issue. Chairman's statement This summarises the results but it is not a legal document so it will be slanted favourably. The most important paragraph is prospects, usually near the end. Directors' report See if there are any changes in accounting practice, which must be reported here. If there are any, have the previous year's figures been adjusted for comparison? Auditors' report Is it 'clean' - in other words have they not said there is anything wrong? Profit and loss account You will have already seen the important figures in the summary but in the profit and loss account you will find a useful analysis of profit between ongoing businesses and (if any) new or discontinued businesses. Balance sheet Look at the group balance sheet if there is one. Compare each item with last year and think about any wide deviations, looking at the relevant notes. Look particularly at net current assets and borrowings. Cash flow Is there a net inflow or outflow? In the latter case try to

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work out why, in case it is a warning. (Fast-growing companies can be highly profitable but still run out of cash.) Notes on the accounts Read the note relating to directors' pay - always of interest! List of directors Does the company have non-executive directors and if so do they seem powerful enough to stand up to the executives? Interim report This is usually quite brief. It shows figures for the first half of the current year compared with the same period last year and the last full year. The figures will not have been audited and there may not be a balance sheet or cash flow statement. Watch out for any accounting changes which affect the comparison. There will probably be a short chairman's statement, including a comment on prospects. MONITORING YOUR INVESTMENTS

It is essential to keep records of your investments - date of purchase or sale, quantity, price and value. It is also a good idea to record successive prices of equity investments, where appropriate, so you can spot a trend. If you have a computer, there are a number of programs for keeping records and share prices can be downloaded and graphs drawn as an aid to investment decisions, including prospective purchases. You can set a stop-loss price for each share held, say 10 or 20% below the purchase price (computer programs are good at this). You do not have to sell when the price falls below it, especially if the whole market is down, but it is a signal to review. A good test is whether you would buy at the current price if you did not already have the shares.

Becoming Your Own Financial Adviser 33

Another vital record is a diary of future events, such as the date any National Savings certificates expire. CASE SCENARIOS Amanda decides her investment objectives Amanda doesn't need to invest for income and as she is young can invest long term, so she decides that her objective should be growth. Bearing in mind that equities perform better than fixed-interest in the long run, she thinks most of her investments should be in equities. Jean knows about stockbrokers Jean's elder brother James, who has been successful, boasts of his investment prowess, but indicates he uses his bank for stock exchange transactions. Jean has heard on Woman's Hour that there may be cheaper stockbrokers and suggests he gets a list of execution-only brokers from APCIMS. James scoffs a bit, but rings later to thank her, because he has found there are cheaper alternatives. He picks out the cheapest and registers in advance with a view to trying them next time. Gwen and Hugh need income in retirement Gwen and Hugh reckon any investments they make should be slanted in the direction of income rather than growth. Also, since retirement is near, they consider that fixed-interest should form a large part of their investment portfolio. POINTS TO CONSIDER FURTHER 1. The P/E ratio measures share price as a multiple of last year's earnings. Comparatively high figures are said to show a greater potential for share price growth. Why is

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that? What should an individual P/E ratio be compared with? 2. What do you consider are the three most important items of information in a company's annual report? Some people say cash flow is more important than profit - why do you think that is? 3. How do you feel about passive as opposed to active investing? Which is the safer route? How far are you prepared to take a risk with your money?

3 Fixed-Interest Investing MAKING BANK/BUILDING SOCIETY DEPOSITS Deposit accounts are designed for money to be left alone for a period, in contrast to current accounts which are intended for frequent transactions. Whilst deposits and withdrawals are easy, these accounts do not have the facilities of a current account such as cheque books. A higher rate of interest is therefore paid. A deposit account is a useful back-up to a current account, with easy transfer from one to the other. As well as being the best place for your cash reserve, the deposit account can also be the first port for your savings, especially for short-term objectives, such as a holiday or Christmas. You need to keep a record of the different amounts you are saving, but there is an advantage in placing them all in the same account, as interest rates may increase with the amount deposited. Understanding interest rates Interest rates on deposit accounts may be fixed or variable but the capital value does not change. There may be higher rates available for notice accounts, where there is a period of notice before withdrawal or a penalty for earlier withdrawal. Thirty days is a common period but there are accounts available for 60 or 90 days, or even longer. More planning is necessary to avoid penalties and these are not suitable for your emergency fund. Another important factor is the amount on deposit. Rates frequently increase at £2,000, £10,000 and £25,000. There may be a minimum balance.

35

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Lump Sum Investment

The frequency of interest payments varies, so rates are compared by using the annual equivalent rate (AER), which takes account of the timing of interest payments. Watch for introductory rates, sometimes called a bonus. These last for a limited period, usually only six months (to attract new investors) and it is the subsequent rate which matters. The final point on interest rates is that it is the after-tax rate which matters for you, so your marginal income tax rate (the highest rate you pay) is a critical factor. Choosing an account

There is a wide choice of account at all levels of deposit and notice period and the situation is constantly changing, so what is best for you today might be different next month. However, when interest rates are generally low, unless you are making a substantial deposit the difference will not be great and it is not worth the bother (and loss of interest) of changing accounts for a small increase. One thing to watch out for, though, is the closure of an account to new entrants, which tends to happen when it has become less attractive and the provider has introduced a new account. They are not bound to notify account holders, although complaints about this have caused some to do so. Therefore it is wise to check the current rate on your account and compare it with the competition. Comparable rates can be found in newspapers and in Which? and other money magazines. Using postal and Internet accounts

A number of banks and building societies have postal and/or Internet accounts. The advantage is that interest rates may be slightly higher because the expense of maintaining branches is avoided. The disadvantage for postal accounts is the delay in transactions, particularly when making withdrawals.

Fixed-Interest Investing

37

However, return by post is generally quick (except at Christmas-time) because they aim to reply the same day, using first-class post. In the case of Internet accounts, transfers in and out are usually from and to a nominated account (such as your current account), which means there is a two-stage operation if you wish to transfer the money somewhere else. INVESTING IN NATIONAL SAVINGS

National Savings (NS) are investment products provided by the government and are therefore a way for the government to borrow from the public. They are mainly longer-term investments. There are minimum and maximum investment amounts for each. In every case the capital value remains intact. Interest rates may be variable or fixed for the period of investment. In the latter case, as general interest rates change, the current issue may be closed and a new issue opened at a higher or lower rate. (The word 'issue' is used to describe the product currently available in each category.) Interest may be tax-free, taxable (paid gross) or taxed (deducted at source). In some cases interest is paid out; in others it is kept in till maturity. Some interest rates are not reasonably competitive at present. Current rates and investment limits are available from post offices, in newspapers, on Ceefax/Telefax or on the Internet. Present rates are shown in Figure 8. Where there are relatively low limits on investment, such as for savings certificates (£10,000), two people, in addition to each investing the full amount, can hold a further investment in trust for each other, thus doubling their joint holding to £40,000. It is also possible to create an income (albeit delayed) from a product which does not pay out interest, such as Savings Certificates, by buying a series of certificates of the minimum investment (in this case £100). If they are

Tax-free Fixed-interest savings certificates

2 years 9th issue 3.55% 5 years 60th issue 3.65%

Index-linked savings certificates

2 years 8th issue 2% above inflation 5 years 20th issue 1.9% above inflation

Children's bonus bonds Y issue

4.7%

Cash mini ISA

5.2%

TESSA-only ISA

5.2%

Premium bonds

prize fund

Taxable Income Income bonds

up to £25,000 £25,000 and over

Pensioners' bonds

Growth Capital bonds series Z

3.5%

4.6% 4.85%

1 year series 6 2 years series 12 5 years series 21

4.8% 4.9% 5%

5.05%

Fixed rate savings bonds £500 £20,000+ £25,000+ 6 months issue 10 4.55% 4.75% 4.95% 1 year issue 9 4.6% 4.8% 5% 2 years issue 6 4.7% 4.9% 5.1% (slightly lower rates are paid if interest is taken out monthly) Investment account

under £500 £500+ £2,500+ £5,000+ £10,000+ £25,000+ £50,000+

3.5% 3.6% 3.7% 3.8% 4.1% 4.3% 4.7%

Note: These rates were current at the time of going to press. Those with an issue or series code are fixed rates for the period - rates are changed by making new issues. In other cases the rates can be changed at any time.

Fig. 8. Current National Savings interest rates.

Fixed-Interest Investing 39

purchased in successive months, then three or five years later they will be cashable in successive months. There is a National Savings Investment Guide which will help you choose between the wide range of products. This, and separate leaflets about each product, are available at post offices. Savings certificates

There are two kinds - those which pay a fixed rate of interest and those which are index-linked, i.e. interest is at a fixed rate above inflation (as measured by the retail price index). There are also two investment periods, two years and five years. The limits to investment for the current issue are £100 minimum and £10,000 maximum. In all cases certificates must be held for the full period to obtain the full interest rate but they can be cashed in earlier at lower rates. Interest is guaranteed for the period, is kept in and is tax free, making such certificates of particular interest to higher-rate taxpayers. On reaching maturity, certificates need to be cashed in or transferred to the current issue (which doesn't breach the limit); the money can be left in but the rate of interest for matured fixed-interest certificates falls to the general extension rate (2.01%), a much lower rate which applies to all NS products which have passed the initial investment period. Children's bonus bonds

These can be bought in units of £25 for a child (under 16), who can hold up to £1,000 in each issue until reaching the age of 21. Interest is guaranteed for five years, is kept in and is tax free. Pensioners' bonds

These are only available to the over-60s. There are three periods for investment - one, two and five years. Interest is guaranteed for the period, is paid out monthly and is

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taxable, for which reason they are mainly of interest to the non-taxpayer. The minimum investment is £500 and the maximum £1 million for all issues. Capital can be withdrawn before the period is up, but two months' notice is required and no interest is paid for that period. Alternatively, immediate withdrawal is possible, subject to the loss of 90 days' interest. Withdrawal after the period is up must be requested within two weeks of the expiry date; otherwise another period of two or five years starts. Reminders are sent. Capital bonds

The term is five years and interest is guaranteed. The minimum investment is £100 and maximum £250,000. In this case gross interest is added to the bond annually and is not paid out till maturity, but is then taxable. (An annual statement is sent for income tax purposes.) Early withdrawal is possible but there is an interest penalty. These may be of interest to higher-rate taxpayers who already have the full allowance of savings certificates and do not need regular income. Income bonds

These are similar to capital bonds but interest is paid out monthly, so they are of more interest to those who require a regular income. However, interest is variable and is taxable. Three months' notice is required for withdrawals, although immediate withdrawal is possible subject to the loss of 90 days' interest. The minimum investment is £500 and the maximum £250,000. Fixed-rate savings bonds

These bonds earn a fixed rate of interest over set periods of time - six months, one year or two years. Rates are tiered so the more you invest and/or the longer the period, the higher the rate.

Fixed-Interest Investing

41

Interest is guaranteed for the period, can be left in or taken out monthly or annually (at slightly lower rates) and tax is deducted. There is an interest penalty for cashing in early. The minimum investment is £500 and the maximum £1 million. Investment account

This is more like a bank deposit account than the other NS products and is convenient for small savers. You can deposit a minimum of £20 at a time. One month's notice is required for withdrawals but these can be immediate, subject to the loss of one month's interest. Deposits and withdrawals are made at post offices. Interest is taxable and can be taken out or left in. Interest rates increase with the amount deposited, in seven bands ranging from under £500 to over £50,000. Current rates are lower than the best building society rates. Ordinary account

This is like a bank current account and is also convenient for small savers. You can deposit as little as £10 at a time. However, there are no cheque books or other facilities such as standing orders. The interest rate is low but is tax free for amounts of up to £70 a year. Deposits and withdrawals are made at post offices. Up to £100 can be withdrawn on demand; larger amounts take a few days. Premium bonds

This is the only form of gambling where you do not lose the stake! An average return on a large investment can be expected in the long run of over 3% and of course there is the chance of a big win. On the other hand, with only a small investment you can go on for years without winning any prize. The minimum purchase is £100 and the maximum holding is £20,000. The top monthly prize is £1 million and

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there are many prizes of lower amounts. Winnings are tax-free. All investors (and particularly higher-rate taxpayers) should consider putting some money into premium bonds. BUYING GILTS

Gilts are British government fixed-interest stocks, described as gilt-edged (gilts for short) as they are considered to be supremely safe. The most important factors are the interest rate and the redemption (repayment) date. There are a few stocks which have no redemption date. The interest rate is based on the face value (the issue value) of each stock and is usually set at the market rate when the stock is issued. The percentage rate on the face value is called the coupon. Interest is fixed for each stock, or in some cases is index-linked, i.e. expressed as a fixed percentage above the retail price index. Redemption is usually set between two dates a few years apart, leaving the government some choice. The face value is repaid on redemption, indexed in the case of index-linked stocks. There are a few old issues which are irredeemable; they are called undated stocks. Market price

This fluctuates in accordance with the relationship between current interest rates and the set rate on the stock. However, the length of time to redemption also influences the market price, bringing it nearer the face value as the redemption date approaches. Another important factor affecting the price movement of gilts is that short-term interest rates tend to be more volatile than longer-term rates. The price also takes into account the timing of interest payments on a stock. The price includes interest from the last payment date until the trading date (cum interest) but

Fixed-Interest Investing 43

from a specified date the seller keeps the next interest payment and the price falls accordingly. (The stock is then described as ex interest.) When interest rates are low, stocks which carry a higher rate of interest on the issue value will be priced above that value and so (other things being equal) the price will fall over the period to redemption. Yield The yield (interest as a percentage of current market price) is expressed in two ways - interest only and redemption, the latter also taking into account the difference between the current price and the redemption value, allowing for the time to redemption. Interest payment Interest is paid half-yearly and is taxable (capital gains are not taxable). It is paid gross i.e. before tax, although you can elect for it to be paid net of tax, except in the case of stock bought through the Bank of England (see below). Buying and selling gilts Gilts are traded on the Stock Exchange and form by far the largest value of dealings there. They are grouped into various categories: redemption less than five years away (shorts); redemption between five and ten years away; redemption between ten and 15 years away; redemption over 15 years away; undated (no redemption date); and index-linked. There is another way for small investors to buy and sell through the Bank of England Brokerage Service. Most stocks are included in it, but not all.

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Lump Sum Investment

Purchases and sales are made by completing and posting a form, which can be obtained at any post office, together with an explanatory leaflet which lists the available stocks. The cost of dealing is lower than through a stockbroker. Dealing is slower this way and you cannot set limits, so it is slightly more risky, but prices would only change significantly if there were to be a change (or expected change) in interest rates. New gilt issues are made by auction, which has the advantage that there is no commission or spread (the difference between buying and selling prices). Fifty per cent of the value must be put up in advance. The competitive auction is not suitable for individuals but you can bid on a non-competitive basis, by which you will receive the stock you have bid for (possibly scaled down if the bids exceed the issue amount) at the average price bid by the experts. There is a mailing list for new issues, which you can get on to by contacting the Bank of England - ring (020) 7601 4878. Choosing a gilt Your tax position is important. Higher rate taxpayers should consider gilts with an interest rate lower than the current market rate because some of the redemption yield is capital growth which is not taxable. Non-taxpayers should go for those with a high coupon rate with a price above par because of the relatively high interest yield. Basic rate taxpayers are usually recommended to avoid gilts with a current market price above par because the capital loss to maturity will probably not be fully offset by the taxed income. Gilt strips Only recently introduced, strips divide a gilt into separate parts, one for each interest payment (a coupon strip) and one for the repayment value (a principal strip).

Fixed-Interest Investing 45

The attraction is the certainty regarding repayment because the principal strip is bought at a discount and the subsequent gain is guaranteed. The disadvantage is that the capital gain is treated as income in the year it is sold or redeemed. Principal strips can be useful when investing for a specific purpose, particularly if protected from income tax in an ISA (see Chapter 7). UNDERSTANDING BONDS The term bond has in the past been the generic term for fixed-interest stocks with security (the borrower is 'bound' to repay capital). Gilts are therefore bonds. However, in recent times the term 'bond' has also been used in the name of some equity-based investments, for example investment bonds issued by insurance companies; these are dealt with in the next chapter. Local and foreign government bonds It is possible to invest in these and they work like gilts. The only difference is that the risk of non-payment is greater, so the yield is higher. Guaranteed income and growth bonds These guarantee a relatively high return over a period, such as five years, with a full return of capital. They are more attractive during a period of falling interest rates, as the level of interest reflects the going rate at the time of purchase. Income payments are made free of basic tax. They are not suitable for non-taxpayers as tax deducted cannot be recovered. With income bonds the interest is paid out periodically whereas with growth bonds it is retained till the end of the investment period. Otherwise, they are identical.

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Lump Sum Investment

High income bonds Here a high fixed rate of interest is paid for a period, usually around five years. The problem with them is that the capital value can be eroded. Usually there is a condition that, if a selected stock market index falls over the investment period by specified amounts, then the capital invested will be reduced by an appropriate percentage. The lesson here is to read the small print. Corporate bonds These are company fixed-interest investments. They operate like gilts as the interest rate is fixed and so the market price varies. Interest is taxable but capital gains are tax free. Debentures and loan stock Debentures are company fixed-interest stocks which are secured on the company's assets. The term loan stock is used to describe unsecured company fixed-interest stocks. Both have redemption dates when the loan will be paid back at a stated price. Like gilts, the rate of interest is fixed and the market price will vary. Interest on loans is payable whether or not there are any profits and takes preference over dividends. Interest rates are usually quoted gross. Also like gilts, capital gains are tax-free. Preference shares These are shares in a company rather than loans to it and usually do not have a redemption date. A fixed dividend is payable out of profits, usually before any dividend on ordinary shares (hence the preference). The market price will vary in accordance with the current rate of interest. Dividend rates are usually quoted net of tax. Other corporate bonds Zero-coupon bonds are sometimes available. Interest is not paid out but is 'rolled up' till redemption or sale and is

Fixed-Interest Investing

47

then subject to capital gains rather than income tax. 'Bulldog' bonds are those issued by foreign companies on the sterling market. They give higher yields because of the greater risk. Eurosterling bonds are issued by companies in the EU (other than UK companies). They are usually bearer bonds, which means they are like currency notes so you need to keep them safe! Corporate bond funds Unit trusts and investment trusts are explained in detail in the next chapter, as they are mostly equity investments. However, there are also corporate bond funds which invest in a number of individual company bonds, thus spreading the risk. High-yield corporate bond funds invest in more risky corporate bonds, which have a higher yield but more risk of capital loss. PERMANENT INTEREST-BEARING SHARES

Permanent interest-building shares (PIBs) are another building society product. As the name implies, there is no redemption date. Interest rates are fixed (usually at higher rates than gilts) and therefore the market value moves with current interest rates. PIBs can be a good investment for a fairly safe higher return when interest rates are expected to fall. THE SAVINGS GATEWAY

This is a proposal to introduce, in 2003, incentives to encourage lower-income earners to save by offering to match savings with additional contributions paid by the government, probably on a tax-free basis. This is still at the consultation stage, but it is expected that there will be a minimum period for saving, perhaps

48 Lump Sum Investment

three years, as well as a maximum amount and an income threshold. On maturity, the savings may be eligible for transfer to an ISA (see Chapter 7) or to the proposed Child Trust Fund (see Chapter 9 under investing for children). CASE SCENARIOS Amanda invests in National Savings

Amanda has some money on deposit for emergencies and intends to put most of her surplus cash into equities but in order to spread the risk she thinks about fixed interest for some. In view of her higher-rate tax position, she goes for tax-free National Savings and decides on a five-year index-linked certificate. Alistair and Jean think about gilts

Some of their inheritance should go into fixed-interest products, they decide. As they think interest rates will fall, they decide to invest in a gilt with a current interest rate below par, which they hope will give them a tax-free capital gain as well as an income. They find one on the Bank of England Brokerage Service list and send off the application form they got from their post office. Gwen and Hugh review interest rates

Before adding to their building society investment they check the interest rate against the competition. They could get more somewhere else and decide that changing now, before adding to their investment, would be worthwhile.

Fixed-Interest Investing 49

POINTS TO CONSIDER FURTHER

1. What are the relative advantages of tax-free National Savings certificates to the non-taxpayer, the standard-rate payer and the higher-rate payer? 2. Would you bother to change your building society deposit account for an extra 1% per annum? What factors do you take into account? 3. Corporate bonds pay higher interest than gilts. Why? Would you go for the higher rate in your circumstances?

4

Investing in Pooled Equity Funds SELECTING INVESTMENT TRUSTS

Investment trusts (ITs) are companies whose business is buying, holding and selling shares in other companies, so they make the investment decisions for you. Investment trust shares can be bought and sold on the stock exchange and dividends are paid. Some companies invest generally while others specialise, either in income or growth shares or in particular sectors, countries or world regions. Some specialise in fixedinterest investments. A newly introduced category - global - recognises the trend towards a world-wide approach to investing, picking out what are thought to be the best companies world-wide, perhaps restricted to a sector (especially high-tech stocks). In any case, many large companies have significant operations extending beyond their national boundaries. The share price is usually at a discount to the market value of the underlying investments (the net asset value or NAV) and the percentage discount varies from time to time as well as between individual ITs at any one time. In recent times discounts have been as high as 10% and as low as 2%. Occasionally the share price is at a premium to the NAV. ITs can borrow money to invest. This is called gearing because the opportunity for growth and/or income increase is geared up. It does of course also increase the risk of loss. The cost of managing the investments is a charge against profits. Eighty-five per cent of income must be paid out. Information about ITs can be obtained from the Association of Investment Trusts - ring (020) 7431 5222. 50

Investing in Pooled Equity Funds 51

INVESTING IN UNIT TRUSTS Unit trusts (UTs) are another form of pooled investment but are quite different from ITs. They consist of a portfolio of shares managed by a professional company but owned separately by a trust. The price of a unit is the total value of the underlying investments divided by the number of units. Units may be income (income is paid out) or accumulation (income is reinvested). Units are bought and sold at varying prices, like shares, any margin between the two being an initial charge which may be as high as 5%. In some cases there is an exit charge instead, which reduces over a period, perhaps to nothing after five years. There is also an annual charge in the form of a management fee, usually 1-2% of the fund value. UTs have a similar variety of investing areas to ITs. Of particular interest may be corporate bond funds, especially those targeted at high-yield bonds. It must be remembered that the capital value of corporate bond funds is affected by changes in market interest rates - a rise in rates means a fall in value and vice versa. High-yield bonds often include foreign company bonds and so are also subject to exchange rate fluctuations. UTs do not have the facility for gearing and cannot be at a discount or premium to the underlying investments, so tend to be less volatile. Many PEPs and ISAs (see Chapter 7) are set up by unit trust managers specifically for investing in their range of UTs and there is a lot to be said in favour of pooled investing in equities. Advisers get an initial commission, so it is worth asking for a rebate, which some offer in their literature - they are called discount brokers. They also get a small annual commission (usually 0.5%). As these commissions cannot be avoided by investing direct it is worth using a discount broker, who may also provide annual or half-yearly statements, possibly with useful performance comparisons.

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Information about UTs can be obtained from the Association of Unit Trusts - ring (020) 7831 0898. Open-ended investment companies

Unit trusts are a singularly British institution and many are converting to the continental style open-ended investment company (OEIC), which have only one price for buying and selling, with separate charges. As they are companies, the 'units' are actually shares. However, there is a proposal that single pricing should become compulsory for unit trusts. Fund supermarkets

There are fund 'supermarkets' or 'networks', where the provider offers (usually over the Internet) a number of pooled investments to choose from, with easy (and cheap) transfers between the funds. They are frequently discount supermarkets, with lower initial charges. Some providers offer a much wider choice than others, so again here it pays to shop around. COMPARING INVESTMENT TRUSTS AND UNIT TRUSTS

One fundamental difference between the two is that a unit trust is open-ended, which means that new investors add to the total sum invested, whereas an investment trust is close-ended, the sum invested not changing during the life of the trust. Investment trusts have more autonomy of choice of when to invest, i.e. can hold cash, whereas unit trusts must invest cash received within a limited period. These differences plus the opportunity for gearing and the variable discount make investment trusts potentially more volatile than unit trusts. On the other hand, the charges for unit trusts have in the past been considered high. Investment trusts can invest in a wider range of assets

Investing in Pooled Equity Funds

53

than unit trusts, i.e. including commodities and unquoted companies. Investment trusts generally have a lower annual management charge, around 0.5%, compared with 1.5% for unit trusts. This saving of 1 % can have a considerable effect over a long period. CHOOSING INDEX TRACKERS There is a category of unit trusts called index trackers, which are set up to match as far as possible a specific index, such as the FTSE 100, the FTSE all-share, the US, Europe or Japan indices. Perfect linking cannot normally be achieved because no fund can invest in every share in the right proportions. Also indices take no account of the cost of buying and selling, which will depress the value of the tracker compared to the index. Charges are lower than ordinary unit trusts because expert advisers are not needed. Initial charges are usually no more than 1 %. Some investment trusts offer index loan stocks, which are directly linked to the relevant index and so can achieve perfect linking. They usually have a set repayment date and pay dividends. As they are unsecured, there is a slight risk of a failure to repay, but they take preference over shares in the investment trust. Index trackers are a relatively cheap and safe way of investing in the stock market. Exchange-traded funds Recently introduced in the UK, these index trackers (also called extraMARK or iShares) are different from an investment trust in that they are open-ended (like an OIEC) and different from a unit trust in that the price varies during the day with the movement of the underlying assets whereas unit trust prices are revised only once a day. There is not a great deal of choice so far, but if they

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catch on there will be many more. In addition to the FTSE 100 and FTSE ex UK, there are iShares for specific categories, such as TMT (technology, media and telecom). Dealing is through a stockbroker. There is no stamp duty to pay and annual charges are low (below 0.5%) They tend to be slightly cheaper than most index trackers. From experience to date, exchange-traded funds seem to track better than traditional index funds, possibly because of the lower charges and reduced internal tax liabilities arising from the way they operate. INVESTING IN FRIENDLY SOCIETY SAVINGS SCHEMES

A friendly society is a mutual insurance and savings organisation operating for the benefit of its members. Usually it has arrangements for sickness and death benefits as well as other forms of insurance and investment. Friendly societies are authorised to offer a tax-free investment linked to their life assurance funds. The maximum investment is £25 a month or £270 a year and schemes run for a minimum of ten years. There has to be a life-assurance element, the cost of which has a slight adverse impact on returns. Income in the scheme is subject to a favourable rate of tax and capital gains are tax-free. After ten years no tax is payable on withdrawal. There are penalties for early withdrawal. Watch out for proportionally high charges because the amounts invested are small. These schemes are often promoted for children. They are a way of involving children's savings in equities but most children are in a tax-free position anyway, so other alternatives should be considered (see Chapter 9). BUYING INSURANCE BONDS

These are pooled investments in the funds of life assurance companies. As the investment is frequently unitised, they

Investing in Pooled Equity Funds

55

are in effect the life assurance equivalent of unit trusts. (Conventional or traditional insurance bonds are not unitised but have become increasingly unpopular with providers as they are less easily explained.) There are usually separate funds for equities, fixed interest and property. Often some of these categories are divided into UK and international investments. There is usually a minimum investment period (often five years) with penalties for earlier termination. However, there is usually no initial charge. Income tax and capital gains tax is payable by the fund at the standard rate and no further tax is payable by higher-rate taxpayers until maturity. Tax deducted cannot be recovered, so they are not suitable for nontaxpayers. Top-slicing relief The tax payable by standard-rate taxpayers on maturity is calculated using top-slicing relief. The original purchase price is deducted from the final value plus any withdrawals. That amount is then divided by the number of years you have held the fund. This gives the extra 'slice' of income, which is added to your other income in the final year. If any of it falls into the higher-rate band, then a further 18% is payable on that amount multiplied by the number of years. Higher-rate taxpayers These will have to pay the extra 18% tax, but not until maturity, the advantage of the deferred tax being that the fund grows with only standard-rate tax having been deducted. If withdrawals are made before maturity, up to 5 % a year is treated as a return of capital, so no additional tax is immediately payable unless the 5% limit is exceeded. The percentage is on a cumulative basis, so you can exceed 5% in a year if you withdrew less in earlier years. There is no need to include the withdrawal on your tax return if it does not exceed 5%.

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On retirement, when your income generally falls, the marginal rate for some higher-rate taxpayers may no longer be above the standard rate band, so income can be taken without further income tax liability (unless it takes you back into the higher rate band). Effect on income tax age allowances and tax credits Another advantage of deferring income applies where otherwise the income would produce cutbacks to the extra income tax age allowances and to certain tax credits. Guarantees Sometimes there is a guarantee of performance (income and/or growth), but it may be subject to the performance of an index over the investment period, such as the UK all-share index or the European Eurostoxx index. Another form of guarantee is that you will get back at least as much as you originally invested. This may or may not be subject to the performance of an index. All guarantees need to be read carefully to see exactly what they mean, bearing in mind that there is an unknown cost from the use of derivatives (futures and options - see Chapter 6), resulting in slightly lower income and/or growth. It is also worth noting that guarantees of this nature may not be worth much, since the average annual return over all recent five-year periods is 10% growth plus 5% in income, a total of 15%, and there is only a 1 in 78 chance of growth over five years falling below 30%. Since life assurance is a requisite part of these funds, your heirs are guaranteed recovery of, probably, your original investment if you die during the investment period. Managed funds

In this case the investments are in a mixture of the life company's funds. Because of this, performance is less volatile.

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You are in effect using the expertise of the life company's managers to choose a mixture which achieves good returns at lower risk. Some funds set off charges against annual bonuses, others do not, so it is necessary to take this into account when comparing. Some providers also charge by investing less than 100% of the amount put in; this is called the allocation rate. Advisers get a commission - try for a rebate. Market value adjustment Most managed funds with an equity involvement carry a provision for a market value adjustment (MVA) in case the underlying assets of the fund are severely depressed at the time of an individual withdrawal due to a considerable fall in the stock market. This is in order to protect the interests of the remaining investors. The application of an MVA is a rare event but to avoid it happening to you, it is wise to ensure that you can be flexible in the timing of your withdrawal so that you can defer it until the MVA is removed. With-profits bonds These are a more conservative form of managed fund. The difference is that the value of the fund is unlikely to fall because annual bonuses (also called reversionary bonuses) are declared but some growth is retained to smooth out returns and pay for terminal bonuses (payable on terminating the investment). With-profits bonds have become a very popular form of investment, particularly with retired people, probably because of their steadiness in growth, despite the disadvantage of not knowing in advance what the terminal bonus will be. On the negative side, in recent years there has been a downward trend in bonus rates. Investment bonds These are similar to with-profits bonds except that they are

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unit-linked, so there is no smoothing. This makes them more volatile. As for with-profits bonds, the income is normally left in, as the objective is growth. Some companies permit investment in a number of their funds, making the bond into a wrapper like an ISA. Transfers between funds within the bond do not create a necessity to pay any accumulated capital gains tax at that point as they would outside it - this is a deferral of tax. Investment bonds are sometimes used as long-term investments for children and grandchildren. Distribution bonds These are similar to investment bonds except that the objective is income, so all the income from the underlying investments is paid out, while the capital value is maintained. They are popular with retired people. Guaranteed equity bonds Some bonds are set up to pay a guaranteed income over a period, perhaps five years, or achieve a guaranteed growth, dependent upon certain criteria being met. The comments above regarding guarantees are important and it should be remembered that higher interest can only be achieved by taking greater risk. Endowments These are usually associated with mortgages. They have recently come under criticism because returns are lower than were expected a few years ago and some holders are being notified that their policy is now unlikely to produce enough money to pay off the mortgage when it becomes due. However, they are a suitable vehicle for lump sum investing and take the form of a one-off lump sum investment in a ten-year policy. There are with-profits and unit-linked varieties, the only difference being a terminal bonus in the case of with-profits, which should be substantial.

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Second-hand endowments There is a market in second-hand endowment policies and these can be a good investment. You buy the policy for a lump sum and unless it is paid-up you need to be able to continue paying the premiums till maturity. As the life assurance element continues on the life of the original investor, you can get an earlier pay-out if that person dies but you need to keep in touch in order to find out if it happens. To spread the risk, you can invest in second-hand endowments via a specialist investment trust. Maximum investment plans This is a fancy name for what is actually an endowment policy - do not be deceived into thinking it is something else. There are also maximum savings plans - identical except they are intended for regular monthly contributions instead of a lump sum. Broker funds

Independent financial advisers and stockbrokers offer broker funds to their clients. These are investments in the funds of a life assurance company where the broker makes the allocation over the individual funds for you. Originally investments were 'fettered' to the funds of the chosen life company, which meant they were akin to 'fund of funds' investments, except that there the life company makes the allocations. However, many are now 'unfettered', i.e. they permit investment in other life companies' funds, unit trusts and even individual shares. The advantage claimed for broker funds is that the IFA/broker has extra expertise in the allocation decision, enough to more than compensate for the higher costs (but costs are not necessarily doubled because there will be some discounting of costs between the two parties).

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CASE SCENARIOS Amanda decides against pooled investments

Amanda prefers the idea of direct investment in equities because she considers she knows enough about business to be able to make her own decisions about which shares to buy and when to buy and sell. Also she hates the idea of paying someone else to choose for her. Alistair and Jean like tracker funds

As they have no knowledge of the stock market, Alistair and Jean prefer pooled investments, at least to start with. They think that tracker funds are a good idea, as they are cheaper to invest in and should do well compared with selective funds. They'll give consideration to putting some of their money in trackers of indices outside the UK, to spread the risk. Gwen and Hugh go for income

Some of the retirement cash will go into equities but they will need income. Gwen and Hugh therefore get advice from a discount broker about the performance of UK income unit trusts and pick out a couple of funds to invest in. POINTS TO CONSIDER FURTHER

1. What are the relative advantages of investment trusts and unit trusts? 2. Do you think a with-profits bond would be a good investment for you? How risky do you think they are? 3. Regular savings are particularly suitable for pooled equity investment because of something called pound/cost averaging - when the stock market it low,

Investing in Pooled Equity Funds

you get more shares or units than when it is high, so that the average price you pay for each is lower than the average of the prices each time you invest. If you are saving to invest, would you invest in pooled equities in this way?

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5 Direct Investing in Equities BUILDING UP AN EQUITY PORTFOLIO

It is not sensible to put all your money in one company. It is better to spread it over at least ten companies, which means having at least £10,000 to invest, as it is not economic to put less than, say, £1,000 in any one due to minimum dealing costs. Consideration should also be given to share sectors. It is risky to have too much invested in one sector. Many newspaper City pages recommend individual shares to buy or sell but this can push the price up or down before you can react. Information is also available on the Internet. Company reports can be obtained to provide more information. There are also tip sheets, which recommend individual shares. They are expensive and one wonders whether the tipper keeps the best ideas to himself. Word of mouth can be useful and it is a good idea to watch out for new ideas and successes, such as, for example, a shop which seems to be doing well or a product which you have bought or is recommended by a magazine or TV programme. Smaller companies

There may be a narrow market in smaller companies' shares, which can make them difficult to buy and (particularly) to sell. Also, smaller companies are more likely to go bust than are larger ones. However, good smaller companies can be valuable investments as they tend to be cheaper than larger companies, have higher dividend yields and provide a greater potential for capital growth and dividend increase. 62

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Fundamental analysis This term is used to describe choosing shares by looking at the fundamentals - the financial results for recent years, including statistics such as profit and dividend trends, the annual and half-yearly reports, recent announcements by the company, share price history, share dealings by directors. In addition, there are the statistics for the sector in which the company's shares sits. Technical analysis It is possible to carry out what is called technical analysis, which can be done on a computer using a proprietary system. Graphs of the price of each share can be drawn and you can superimpose on them the relative movement of an appropriate index, short- and/or long-term averages and stop/loss points. There is a lot to be said for using both types of analysis rather than only one of them. International shares It has become easier to invest directly in shares outside the UK, following the introduction of Jiway, which is a recognised investment exchange under the jurisdiction of the Financial Services Agency. The cost to brokers is set in euros at an amount of less than £5, so their charge to you should not be astronomic. When to buy and sell Theoretically you should buy shares when the market starts going up and sell when it turns down but few of us can distinguish a blip from a trend. In any case, individual shares may not move with the market. There is a great tendency to sell a share which has fallen in price, particularly if it goes below the purchase price, and to buy more of a share which has risen. This may be the right action but decisions should be based not on the past but on expectations of the future. Cut losses, but let profits run. However, it can be sensible to sell part of your holding of shares which are

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showing a good profit, leaving in, say, the equivalent of your original investment, particularly if the shares are highly volatile. Do not churn (continual dealing) as dealing costs can mount up. Above all, do not panic when prices fall; take the long view - most big market falls (sometimes called corrections) are followed by a fairly quick recovery and what seems a catastrophe at the time later becomes only a small blip on a trend line. Defensive stocks

Shares in some companies are recognised as defensive, which means they are worth holding in periods of uncertainty. Examples are: stores - people need to live and therefore will buy clothing, food and drink; utilities such as electricity, gas, oil and water - likewise, there has to be a continuing demand; transport such as bus/coach and rail (but perhaps not air) - demand for these will also hold up. Value investing

This term describes the purchase of cheap, unpopular shares, as opposed to growth investing - sectors expected to have considerable growth. Together, the two approaches are called style investing. Suitable shares for value investing are considered to be those with high cashflow, dividends and earnings yields, and high ratios of sales and book value to share price. Over the very long run, value shares appear to outperform growth shares, possibly because of the greater volatility of the latter (the tortoise-and-hare phenomenon!) Hedging

There are various ways of protecting your shares from an expected fall in the share price (or in the market as a

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whole) without actually selling them. They also have the advantage of locking in a profit but deferring a potential capital gain. All use the techniques of 'going short' - selling something you have not got, which can be very risky on its own, but because you do hold the shares the high risk is removed. For information on these techniques, see the section on CFD trading below, and on options and spread betting in Chapter 6. DAY TRADING

A more risky way of investing in individual shares is day trading, where you buy and sell (or the reverse) the same day. You need to be able to monitor the market continually so that you can close (sell what you have bought or vice versa) as soon as you have achieved your objective. The big advantage is that you do not put up the cash (except for any deposit your stockbroker requires), you just collect or pay the difference. Stamp duty as well as commission is still payable. The same objective can be achieved by trading both ways within the settlement period, normally five or ten days but extendible to 20 or even 25 days at the cost of a wider spread. OCO orders This technique is designed to produce profits whether a share price goes up or down (it sounds like Utopia!). OCO stands for one cancels other; another name is stop entry. It can be used for a share where you expect a movement (such as when a results announcement is imminent) but you do not know which way the price will go. The OCO order ensures that the share is bought for you if the price goes up by a small amount and sold (i.e. sold

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short) if it goes down. If the price movement does not meet the minimum, then there is no transaction. The argument for using the system is that once the share price starts moving it continues in the same direction, so you can make a quick profit. You are still left with a decision about the timing of the reverse transaction to close out your position. The risks are obvious - the price change may not continue in the same direction. In particular, if it goes up after you have sold short, the potential losses are unlimited. So there is a need to monitor the share price throughout the day. Not many brokers offer this service. CFD TRADING

A way of gearing up your trading is CFD trading (contracts for differences - sometimes called margin trading), where there is a virtual share which can be as little as one-tenth of the actual value but you gain or lose the full value of the share price movement. It is therefore highly volatile and up to ten times as risky as ordinary investment in shares. You can go 'short' - sell to buy back later - on any share. Stamp duty is avoided but capital gains tax applies. You trade at the cash price per share and pay a transaction charge (confusingly called the spread) calculated as a percentage of the value of the transaction. Also you put up between 10 and 25% of the underlying contract value. During the period of investment your account is debited daily with interest charges (currently 8.5% per annum) and credited with any dividends which become due. (In the case of a short investment, the debits and credits are in reverse, but the interest rate is lower, currently 4%.) You can trade under what is called controlled risk protection, which enables you to place a stop-loss level at which your position will be closed should the market move against you. There is a higher transaction charge for this.

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You can also trade in share futures via CFD (see Chapter 6). You do not deal through your stockbroker but directly with one of the specialist dealers. Hedging It is possible to use a short CFD position to avoid an expected fall in the share price without actually selling the shares. It can also be used to lock in a profit on an existing shareholding without realising a potentially taxable capital gain. Similarly, if you expect to have money to invest at a later date, or you have to sell shares now to raise some urgently needed cash and you think the market is going to rise, you can buy CFD shares. These techniques are called hedging and are the opposite of risky because there is more risk in not doing it. However there are alternatives - see Chapter 6 under options and spread betting. INVESTING IN EMPLOYEE SHARE INCENTIVE/OPTION SCHEMES

Under share incentive schemes employees are given shares or the right to buy shares. In the case of share option schemes the employing company grants the employee an option to buy shares in the company at some date in the future at a price based on the current share price. Hopefully the share price will increase during the intervening period, so that when the option is exercised a profit is made. However, if the reverse happens nothing is lost, as the option does not have to be exercised. If the scheme is one permitted by the Inland Revenue, no income tax (or National Insurance contributions) are payable by the employee, except on any dividends paid on option shares after the option is exercised. Capital gains tax is payable only if and when the shares

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are subsequently sold (not when an option is exercised) and the more favourable taper relief applies (see Chapter 10). Shares arising from the first three types of scheme shown below can be transferred to an ISA within 90 days of exercising the option (without counting against the current year's limits), thus ensuring longer tax-free ownership. If your employer has a scheme which is approved by the Inland Revenue you should consider joining, as the tax-free benefits are significant. The following schemes are approved by the Inland Revenue: Savings-related schemes

These are linked to a save-as-you-earn contract (SAYE) and the total option value is limited to the maximum SAYE contract value, i.e. up to £250 a month plus the bonus after three years equal to 2 times the monthly contributions, or 6.2 times after five years. The scheme must be open to all employees, with a qualifying period of service not exceeding five years. The way it works is that at the commencement of the contract the employee starts an SAYE scheme with a bank or building society chosen by the employer and at the same time is offered an option to buy shares in three or five years' time, at a price which can be up to 20% below the current market price. Clearly if the shares go up in value over the period a profit is made. If the value of the shares goes down, all is not lost as the option does not have to be exercised and the SAYE savings scheme bonuses are worthwhile in themselves. The bonus received at the end of the SAYE contract is tax-free. Contributions then cease (although you can start again) but in the case of a five-year contract, if the money is left in for a further two years instead of being used to buy options or withdrawn, a further bonus equal to 5.7 times the monthly contributions is received. The bonuses are equivalent to 3.67% per annum after

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three years, 3.99% after five years and 4.07% after seven, tax-free. In the case of SAYE contracts terminated before the expiry of the contracted period, no bonus is paid but interest of 3% a year is paid instead. CGT is calculated on the gain over the option price but taper relief starts from when the option is exercised. All-employee share plans (AESOPs) This new type of scheme began in the year 2000. As the name implies, AESOPs must be open to all employees, although a qualifying period of up to 18 months is allowed and the allocation amounts can be tied to length of service and/or hours worked. Allocations can also be based on performance. There are three sections: free shares - employees can be given up to £3,000 of shares free of tax and NICs; partnership shares - employees can be allowed to buy shares out of pre-tax income up to an annual maximum of £1,500; matching shares - employers can match partnership shares by giving employees up to two free shares for each one bought. Free and matching shares must remain in the scheme for at least three years; partnership shares can be taken out at any time. Income tax and NICs are payable on the initial value of the shares if they are taken out after three years but this is avoided if the shares are left in the scheme for five years. Capital gains tax will be payable only on the increase in value after the shares are taken out. If left in the scheme till sold, no CGT will be payable. Up to £1,500 a year of dividends paid on the shares will be tax-free if used to buy more shares in the company.

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Profit-sharing schemes

Companies can allocate a proportion of profits to the acquisition of shares in the company for the benefit of eligible employees. The maximum value per employee in any tax year is £3,000 or 10% of salary, whichever is the greater, subject to a maximum of £8,000. The shares must be held by trustees for at least two years. Once they are transferred to employees they can be sold but income tax and National Insurance contributions are payable on the initial market value if the shares are sold within four years of the original allocation, the rate reducing to 75% of the applicable income tax rate if sold between four and five years. Thereafter they are only subject to capital gains tax. Dividends are taxed in the normal way, whether the shares are held by the trustees or the employee. Schemes must be open to all employees but a qualifying period of service up to five years is permitted. Schemes must be merged into an all-employee scheme after April 2002. Company share option plans (formerly executive schemes)

Unlike the other schemes, company plans may be selective in membership. There is an upper limit to the market value of shares when options are taken up, of £30,000 and a three-year minimum period before options can be exercised. There may also be a requirement for minimum productivity improvement before options can be exercised. Discounts are not permitted in this case - options must be offered at the full current market price. Cash will be required to buy the shares when the option is exercised and usually there is an arrangement with a stockbroker for immediate sale of some at least of the shares, to raise all or part of the cash, with a temporary loan to cover the period between sale and receipt of proceeds. The usual tax reliefs apply.

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Enterprise management incentives This further new scheme also began in the year 2000. It is for key people in smaller companies, i.e. independent trading companies with gross assets not exceeding £15 million. Any number of employees can each be granted options within a total for the company of up to £3 million in value of shares. The usual tax reliefs apply. Unapproved share option schemes Although there are no tax reliefs on unapproved schemes (apart from the more favourable capital gains tax taper relief because the shares are in the employing company), it can still be worthwhile joining in, as the potential gain from an increase in value over the option period, even after paying additional income tax and National Insurance contributions, may well be worth having. BUYING SHARES IN YOUR EMPLOYING COMPANY

Any shares you hold in your employing company, whether through share option schemes or direct, are treated as business assets for the purpose of CGT taper relief and are therefore more tax-efficient than other equity investments. The only thing to watch is the risk of having too many of your investments tied up in the company which employs you. INVESTING THROUGH AN INVESTMENT CLUB

Investment clubs are organisations which arrange cooperative investing. Funds are built up by contributions from individual club members, who meet regularly to review their existing portfolio and select further investments, which are made by the club on behalf of the members. The advantage is the saving in cost from bulk buying and

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the spreading of risk over more individual shares than you could buy on your own with the same amount you put in. The disadvantage is that you have to go along with the majority decision, whether you like it or not. The Association of Investment Clubs will provide details of any club in your area and tell you how to start one. Information can be obtained by ringing ProShare on (020) 7220 1730. GETTING SHAREHOLDERS' PERKS

Some companies offer perks to shareholders, usually in the form of a discount on goods or services they supply. There is usually a minimum shareholding to qualify. Experts warn not to invest in a company merely to get the perk; the share should be worth buying for its intrinsic value. A guide (priced £3 but possibly free) can be obtained from Hargreaves Lansdown (tel: (0117) 988 9880) or from Barclays Stockbrokers (tel: 0845 7777 100).

CASE SCENARIOS

Amanda starts investing in equities Amanda decides to build up a portfolio of individual shares by using technical analysis. She sets up on her computer price charts for a number of shares. For each share, as well as the graph line showing the movement over the last two years, she adds lines comparing the prices with the all-share index and short-term and long-term moving averages. Finally, she inserts a 10% stop-loss line. She picks out ten shares which look likely to grow in value, based on past performance. Then she thinks about sectors and studies the last annual reports to see whether she still thinks she has made the right choice. Then it is time to contact a stockbroker.

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Jean joins the company share scheme

The company Jean works for has a share scheme. As a part-timer she has not been interested, but having read about the tax advantages of share schemes, she decides to join. There is an SAYE scheme, which she can join immediately, and she goes for the maximum SAYE investment of £250 a month. The grapevine says there will be one of the new all-employee schemes later in the year, which she may also join. Hugh buys shares in his employing company

His employer is a very successful company and Hugh has every reason to think this will continue. So although he is nearing retirement, he decides he will invest some of his lump sum in that company's shares, but not too much because his pension comes from a company scheme and he doesn't want too many eggs in one basket. POINTS TO CONSIDER FURTHER

1. You have decided to start investing in equities. How do you decide which shares to buy? 2. How do you feel about investing in your employing company? Do you think it is too risky, because you might lose your job as well as your savings? What is the advantage over other shares? 3. If you have bought a share but the price has since fallen, should you cut your losses? Does it make any difference if the whole market has suffered a set-back? What is the most important factor in making your decision?

6 Making Riskier Investments COMMERCIAL FORESTRY HOLDINGS

The advantage of this investment is that it is free of income and capital gains taxes and, if held for at least two years, is excluded from your assets for inheritance tax purposes. The disadvantage is extreme illiquidity and volatility in value. INVESTING IN COMMODITIES

Anyone can buy a commodity, whether it be a metal, farm produce such as grain or coffee, or even wine. The objective is to hold the commodity in the expectation that it will increase in value. There is extra expense because of storage, insurance and perhaps shipping costs. A more risky way of investing in commodities is to buy or sell futures or options (see below) in commodities. A less risky way is to invest in companies or investment or unit trusts which deal in commodities or commodity companies. BUYING CONVERTIBLES

These are bonds or shares issued by companies, earning fixed interest or dividends, which are subsequently convertible into equity, i.e. ordinary shares. They are usually redeemable before conversion. Conversion can take place after a specified date in the future at a set price which is usually in excess of the ordinary share price when the convertible is issued. The conversion premium is the amount by which the equity 74

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share price must rise to make conversion worthwhile; it can be a negative amount. Initially, market price is controlled by current interest rates. As the conversion date nears, the equity share price has increasing influence. Convertibles can be very valuable if the share price goes up but meanwhile should be judged on the fixed return. UNDERSTANDING EISs AND VCTs

EISs are enterprise investment schemes, where the investment is in one company. VCTs are venture capital trusts, which are pooled investments. In both cases, they are investments in new companies. Investments for at least five years (three years for new issues after 6 April 2000) in new qualifying schemes receive tax relief at 20% at the time of investment. The annual limits are high - £100,000 in each case. Capital gains are tax-free and, in the case of VCTs, so are dividends. Furthermore, CGT liability on any investment realised to make the investment can be deferred till the new investment is realised. Losses on disposal of unquoted shares in an EIS investment can be set off against income. Also the allowances on EIS investments remain even if listing of the shares is sought within the initial period. But these investments are risky because they are in new companies - very risky in the case of EISs, where all the money is put into one company, less so for VCTs where the risk is spread. BACKING FILMS

This is very risky as few ventures succeed. There is a tax advantage - production costs receive 100% relief from income tax provided they are less than £15 million and are at least 70% insured in the UK.

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INVESTING IN FUTURES AND OPTIONS

Futures are a commitment to buy (a call) or sell (a put) at a set price (the strike price) on a future date An option is similar but is a right rather than an obligation. Both are known by the collective term derivatives, because they derive from something else, such as a share in an individual company. Because the price is only a fraction of the underlying share price, they are in effect highly geared - and very risky. If you think about trying futures or options (or any other form of risky investing), do some experimental dealing (paper trading) first, to see how successful you might be. Universal stock futures (USFs) widen the availability of futures and options contracts to major US and European shares as well as UK shares. Futures

In the case of futures, the cost of failure can be very high, unlimited in the case of a put (selling forward a share you do not have, which you will have to buy to deliver on the relevant date) because there is no limit to how high the share price can rise. Investing in futures is not recommended unless you really know the market in that share. Options

Options are less risky because there is no commitment and the most you can lose is the cost of the option. Options can be of two kinds - traditional, where no further action can be taken until the relevant date, and traded, where the option can be bought or sold throughout its life. Dealings are in units of 1,000 shares. In addition to individual large company shares, options are available for the FTSE 100 index. Then there are other areas, such as commodities (see above). Options have an intrinsic value and a time value. The intrinsic value compares the option price with the current

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share price. The option is 'in the money' when the option price is the lower and 'out of the money' when it is higher than the share price. The time value depends on the length of time the option has to run till the final exercise date. Investing in options requires good knowledge of the market and a means of following the prices during the day, as urgent action may be needed. Options can, however, be protective of your investments. If you think the market is going to fall, rather than sell all your shares you can sell options. If the market falls you make a profit on the options to set off against your share losses. If not then you let them lapse. Similarly, if you expect to have money to invest at a later date, or you have to sell shares to raise some urgently needed cash and you think the market is going to rise, you can buy options. These hedging techniques are protective of your investments, at a price. However, there are alternatives see Chapter 5 under CFD trading and below under spread betting. Combination strategies such as straddles, where you both buy and sell options at the outset, and other more sophisticated techniques, are available. BECOMING A LLOYD'S NAME Lloyd's of London is an insurance organisation. Members (called names) who put up capital as underwriting collateral get 100% relief from inheritance tax provided they have been members for at least two years. However, you first need to have large sums to invest and your liability is unlimited so, although it can be very profitable, it is extremely risky. USING OFFSHORE FUNDS You can invest in investment trusts and unit trusts based

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outside mainland UK, in tax havens such as the Channel Islands. If you are resident in the UK, both income and capital gains are taxable in the UK and there is no indexation or taper relief for gains, but income in certain funds is 'rolled up', i.e. left in, and is not subject to tax until disposal of the investment. On disposal the total gain is treated as income but this might be advantageous to you if you are going abroad to live before then or if your income after retirement is such that you have a lower marginal tax rate. Not many people fall into either category. Charges can be much higher than in the UK. Also investment protection is lower than in the UK and in some places is non-existent. BUYING PENNY SHARES

Shares with a low unit value (though not necessarily a penny) are known as penny shares. The official definition is where the bid/offer spread exceeds 10% of the share price and the market capitalisation of the company is below £100 million. Often they are companies which have been in trouble and the share price has fallen to a very low level. There is a proliferation of penny share tipsters and enormous profits can be made but also enormous losses. Penny shares are very risky because: the wide bid/offer spread needs a high percentage increase to cover it; they tend to be highly volatile; they can be difficult to sell because there is a small market. HOW SPLIT FUNDS WORK

These are investment trusts with a fixed life, where the

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shares are divided into more than one category. The simplest form is a split between capital shares and income shares, where the income shares receive all the income and the capital shares all the capital growth. Capital shares are more risky because at the end of the investment period the income shares are paid back at, usually, the original investment amount and the capital shares receive the balance. They may be of particular interest to higher-rate taxpayers as there is no income tax to pay, only capital gains tax at the end. Income shares are less risky and may be of more interest to those needing income, such as pensioners. There are other variations: •

Zero-dividend preference shares (zeros), which receive no income during the investment period. Instead they are repaid at a fixed amount on redemption, which is taxed as a capital gain rather than as income, so the yield is known at the outset. They have first claim on the assets at redemption. There is a slight risk with zeros, as there could be insufficient assets to meet the final commitment and for this reason the yield tends to be over 7%, but in fact there has never been a failure so far. Comparative risk is measured by the 'hurdle rate', which is the annual amount by which the asset value can fall before the redemption value is cut back. It is expressed as a negative percentage of the asset value. Zeros could be good for investing for school fees, for example. Highly geared shares, which receive income plus growth, there being no capital shares, the other part of the split usually being zeros. Participating income shares, which receive some of the capital growth as well as all the income. Stepped preference shares, which receive dividends increasing in steps over the period of investment.

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BETTING ON FINANCIAL SPREADS

Spread betting is really gambling rather than investing and is very risky. You bet on increases or decreases in the price of an individual share (or an index, interest rates, currency movements, commodities, futures and options or property values). You are quoted the spread (buying and selling price) of a share three and six months ahead and you buy (an up bet) or sell (a down bet) at the appropriate price, depending on whether you are gambling on a rising or falling market. Your bet will be at so much a point, usually a minimum of £5 (these amounts are called units). If you get it right, you collect the movement times the price per point but if you get it wrong you pay it. For example, if the spread on the FTSE 100 index is 6,000 to 6,100, you bet on an increase at £10 a point and the spread goes up 100 points to 6,100 to 6,200, you gain 100 x £10 = £1,000. However, if it goes down to 5,900 to 6,000, you lose the same amount. So profits and losses are unlimited, but you can close out at any time (even outside normal stock exchange trading hours, as it is a 24-hour market) in order to lock in your profits or limit your losses. As it is gambling, no tax is payable on any gain you make but of course any losses cannot be set against any other taxable gains. Betting tax is included in the spreads, which are wider than on the underlying shares. Flotations

One important area for spread betting is flotations (such as where a new company comes to the market) because usually only institutions can subscribe; private investors must wait till the first day of trading, when the big price increases frequently associated with flotations have already taken place. In this case, spread betting offers the opportunity to participate, because spread betting companies operate a

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'grey' market based on what they expect will be the first day's closing spread. Selling short

Selling the spread is a suitable substitute for 'selling short' - selling shares you do not have because you expect the price to fall, so that you make a profit when you buy back at the lower price - a process which is difficult in the UK stock market itself. You can also hedge your investments - protect them against a fall in prices without selling the shares. Instead you sell the spread, for an individual share or for your whole portfolio (by choosing the most appropriate index). This way you avoid brokerage fees and stamp duty as well as capital gains tax. Similarly, you can buy spreads to lock in an expected future rise in prices of shares you have had to sell or have not yet got the cash to buy. It is therefore an alternative to hedging via CFD trading (see Chapter 5) and options (see above), which are taxable and for which you do have to put up cash to buy them. BUYING WARRANTS

A warrant is a right (but not an obligation) to subscribe for shares, or another form of security, at a set price on or during a set future period. They are usually issued as part of an issue of new shares, particularly by new investment trusts, but once issued they have their own market value. Warrants are only different from call options (see above) in that they are issued by the company itself, most often by new investment trusts. They have all the same qualities as options - high gearing and therefore high volatility and a risk of losing all the investment if the underlying share never reaches the option price. They are freely traded on the Stock Exchange. Unit trusts specialising in warrants are available -

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because they invest in a number of warrants, the risk is spread and so reduced. CASE SCENARIOS Amanda goes for a VCT

With her high marginal tax position, Amanda can invest in a VCT and save 20% tax on the investment, thus reducing the cost to 80%, which means in effect a 25% gain to start with and the prospect of further tax-free gains over the three-year minimum period. She prefers a VCT to an EIS as it should be less risky, the investment being spread over a number of companies instead of in just one. Alistair considers options

As Jean now has options on shares in her employer, Alistair has become interested in the concept and considers whether to buy stock market options. Reading up about it, he thinks it would be best to go for traded options, as the investment can be realised during the option period. He also favours those based on the FTSE 100 index, as they are less risky. However, the experts point out the need to be in continual touch with the stock market, as it may be necessary to sell quickly during the day. This would not be convenient, so he gives up the idea, for the time being! Gwen and Hugh favour income shares

Gwen hears about income shares in split capital investment trusts on the Money Programme on the radio. She tells Hugh about them, because they sound like a good idea for providing income during retirement. They decide to find out more and put them on the list for the pension lump sum.

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POINTS TO CONSIDER FURTHER 1. Would you consider investing in convertibles? In what circumstances would an initial fixed-interest return followed by an equity investment be attractive? What is the conversion premium? 2. What are the relative advantages and disadvantages of zeros in a split capital investment trust? 3. Why is a VCT less risky than an EIS? What additional tax benefit does a VCT have?

7 Understanding ISAs, PEPs and TESSAs ISAs and PEPs are not types of investments in themselves but 'wrappers' which can be placed around various types of investment in order to get tax advantages. So it is necessary to choose the type of investment you wish to make within the ISA or PEP. CHOOSING INDIVIDUAL SAVINGS ACCOUNTS

ISAs replaced PEPs and TESSAs for new investments after April 1999 and are guaranteed to run for ten years. The annual limit for investment is £7,000 (£5,000 from April 2006). Income and capital gains in an ISA are tax-free and dividends receive a 10% tax credit until 2004. Investments can be in three components: up to £3,000 (£1,000 from April 2006) in a cash component - in banks, building societies, National Savings products (the taxable ones of course); up to £1,000 in an insurance component single-premium life assurance policies such as with-profits bonds; up to the full £7,000 (£5,000) in stocks and shares investment or unit trusts, preference shares, bonds and gilts or directly in equities (a self-select ISA). There are no geographical limits as there were for PEPs. There is a question mark over the value of the insurance component because insurance-linked products pay income 84

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tax (albeit at a favourable rate), which cannot be recovered and no more tax is payable on investments outside an ISA except for higher-rate taxpayers. Shares arising from employee share option schemes (see Chapter 5) can be transferred to a stocks and shares ISA without counting against the annual limit. Although 18 is the starting age for ISAs, 16 and 17 year-olds can invest up to £3,000 (£1,000 from 2006) in a cash ISA. There are three kinds of ISA: Maxi-ISAs - up to the full £7,000 (£5,000) is invested with one provider, although it can still be broken down into two or three components. Mini-ISAs - you can have one, two or three providers, one for cash, one for insurance and one for stocks and shares (but you cannot forgo either the cash or insurance mini-ISA to put £4,000 in stocks and shares). TESSA-only ISAs - when a TESSA expires, the capital element (but not the interest) can be re-invested in a cash or TESSA-only ISA without counting towards the annual ISA limit. You cannot invest in both a maxi-ISA and a mini-ISA in the same year. Income can be left in or withdrawn but once taken out neither income or capital can be put back into that year's ISA. CAT standards exist for ISAs (charges, access, terms) to protect inexperienced investors but providers do not have to follow them. See Figure 9 for details. Are they good value? There has been some debate about the value of PEPs, particularly for standard-rate taxpayers, since not many people pay capital gains tax and the extra charges could be greater than the income tax savings. However, this dates

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CAT standard for cash ISA Charges

No charges of any kind (except for replacement documents).

Access

Minimum transaction size no greater than £10. Withdrawals within 7 working days.

Terms

Interest rate no lower than 2% below bank base rate. Upward interest rates to follow base rate changes within a calendar month (downward may be slower). No other conditions (such as a limit on frequency of withdrawals).

CAT standard for insurance ISA Charges

Annual charge no more than 3% of fund value. No other charges (such as for a guarantee surrender value).

on

Access

Minimum premium no more than £250 lump sum a year or £25 a month.

Terms

Surrender values to reflect the value of the underlying investments. After 3 years, surrender values should at least return the premiums.

CAT standard for stocks and shares ISA Charges

Annual charge no more than 1% of net asset value (including any additional charge for ISA wrapper). No other charges.

Access

Minimum saving no more than £500 lump sum a year or £50 a month.

Terms

(For pooled funds such as unit trusts, OEICs and investment trusts:) Fund at least 50% invested in EU listed securities. Units and shares to be single priced at mid-market price. Investment risk to be highlighted in literature. (Plus, for investment trusts:) Gearing must not exceed 10% of net asset value. Split funds are not permitted.

Common requirements for all ISAs Commitment to decent straightforward treatment of customers. No bundling (i.e. requirement to buy another linked product). Undertaking to keep to the CAT standards after the product is sold.

Fig. 9. CAT standards for ISAs.

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back to the time when PEPs could only be invested in equities. The same questions arise in connection with ISAs. Figure 10 tabulates the return required to recover the annual charges. Statistics of returns over a period are only available for the time when PEPs were limited to equities. They show that equity investment through a PEP achieved a higher return although it took a lengthy period for the difference to be significant (see Figure 11). Corporate bond ISAs and PEPs Now that ISAs and PEPs can be invested in company fixed-interest stocks and shares, producing more income than equities at least to start with (as well as incurring less risk), there will be a tendency, particularly in the case of higher-rate taxpayers, to use ISAs and PEPs in this way. Another reason is that the full amount of tax deducted at source from company fixed-interest stocks can be recovered by the ISA manager instead of the limited recovery of tax deducted from dividends. Choosing an ISA Even when you have decided on the type of ISA you wish to invest in, there is still a wide choice. Here are some questions to ask the ISA provider: What are the initial/exit and annual charges and are they charged to income or capital? What are the dealing costs (if applicable)? What is the charge for transfer to another provider? Is there any charge for switching between the provider's own funds? Are there charges for collecting dividends, getting company reports and attending AGMs? It is possible to have a self-select share ISA in which you choose which shares or units to invest in and you can trade

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Annual charge % 0.50 0.75 1.00 1.25 1.50 1.75 2.00

Yield needed by taxpayer 20% 40%

2.95 4.41 5.88 7.34 8.81 10.28 11.75

1.47 2.20 2.94 3.67 4.40 5.14 5.88

Notes The tax saving for basic rate taxpayers is only 20%. Provision is made for 17.5% VAT on the annual charge. No prevision is made for any initial or exit charges, or any charges for receiving annual reports, etc. Higher returns are required by basic rate taxpayers if invested in shares, as tax rebate on shares is now only 10%.

Fig. 10. Relationship of ISA and PEP charges to tax savings.

Fig. 11. The added benefits of a PEP over direct investment in unit trusts.

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in the usual way (this also applies to PEPs). There is no specified limit as to how long you can hold cash - the criterion is an intention to invest. Putting all your annual share ISA money into one unit or investment trust, while economical, can be somewhat risky, especially in the case of an ISA mortgage, but you can spread the risk by choosing a different investment sector for each ISA year. Fund supermarkets (see Chapter 4 under unit trusts) are worth considering for ISAs. Further information There is a great deal of information on ISAs, mostly from investment or unit trust providers. Usually you can choose which funds to invest in from those made available by the provider. The Association of Investment Trusts (AITC) has a guide on investment trust ISAs and many discount brokers produce guides from time to time. There is also an Inland Revenue leaflet IR89. See Appendix B for how to obtain any of these. KEEPING UP YOUR PERSONAL EQUITY PLANS While these are not available for new business, existing PEPs can be retained. All income and capital gains within a PEP are free of tax. Also PEPs will continue to receive a 10% tax credit on dividends until 5 April 2004. There are still general PEPs and single-company PEPs, the latter being limited to one company, but the two can now be merged, so the restriction to a single company can now be avoided. Also, transfer of part only of a PEP is now permitted. Investments in PEPs can be changed, the only limitation being that in a single-company PEP the proceeds of the sale must be reinvested within 42 days. There is no limit to the time that money in a general PEP can be left on deposit in cash form, providing there is an intention to reinvest.

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The qualifying rules have now been extended from the previous more limited rules to the same rules as for ISAs. DEALING WITH YOUR TAX-EXEMPT SPECIAL SAVINGS ACCOUNT

It is the interest which is exempt from income tax. The maximum investment was £3,000 for the first year and £1,800 a year thereafter, up to a maximum of £9,000. The money has to be left in for five years from commencement to get the tax exemption, although it is possible to take monthly payments of the non-tax-free element of the interest, i.e. 80% of it. It is possible to cancel the contract and withdraw the full amount (but not part) within the five years but the tax exemption is entirely lost. It is also possible to transfer from one provider to another, although the provider may impose penalties. TESSA savers trapped in accounts with low rates of interest can now get compensation. Claim from your provider and if necessary take it up with the appropriate Ombudsman. TESSAs are not available for new investment but existing TESSAs run till maturity and then the capital element (up to £9,000) can be transferred into a cash ISA or a TESSA-only ISA without affecting the current year's ISA limit. The interest element of the TESSA cannot be rolled over into an ISA without affecting the current year's allowance but interest subsequently earned in an ISA can be left in. There is no minimum period of investment for an ISA, as was the case for a TESSA, but once cash is withdrawn it cannot be reinvested without counting towards the current year's ISA limit. A TESSA-only ISA enables you to move your TESSA savings away from a cash ISA into a stocks and shares ISA.

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CASE SCENARIOS

Amanda buys a maxi-ISA Amanda wishes to take full advantage of the tax saving on ISAs and decides to set up a self-select maxi-ISA so that she can choose her own investments. With £7,000 to invest this year, she chooses two shares from her 'system'. Alistair and Jean choose mini-ISAs Alistair and Jean wish to spread their investments so decide to put £3,000 in a cash mini-ISA, £1,000 in an insurance mini-ISA and the balance of £3,000 in a unit trust stocks and shares mini-ISA. They would prefer not to invest in the insurance component if they could increase their investment in one of the other categories, but this is not permitted. Gwen and Hugh discuss their TESSA Gwen and Hugh started a TESSA when TESSAs first began and on maturity the capital value was rolled over into a 'second-generation' TESSA, which is due to reach maturity in 2003. By then, Hugh will have retired and they will need income, but they think they will roll over the capital value again to preserve it, and then draw out the interest on a monthly basis. POINTS TO CONSIDER FURTHER

1. What are the relative merits of maxi- and mini-ISAs? 2. Why is the insurance component of an ISA not as attractive as the other two components? 3. If you have a PEP and cannot afford to start an ISA this year, what are the advantages and disadvantages of cashing in the PEP and reinvesting the proceeds in an ISA?

8 Investing for Financial Health ACCUMUMLATING AN EMERGENCY FUND Building it up

You should have at least one month's income in your cash reserve, preferably more. The alternative, only applicable if you are paying off debt or building up your reserve, is a borrowing facility, that is a source of emergency finance from somewhere else. This could be a bank overdraft facility or unused credit card balance. The trouble with these facilities is that if you use them they are expensive, so you need to build up your emergency fund as soon as possible. Another potential facility is your immediate family; would your parents, for example, be able and willing to make a temporary loan? Depositing it safely

Use a bank or building society deposit account. Instant access is best, even though higher rates of interest may be available on notice accounts, because the money might be needed in a hurry. Higher rates are usually available on higher amounts, so it is worth using the same account for any short-term savings such as for your holiday. Postal and Internet accounts often offer higher rates. Rates change and it is important to check regularly. Comparable rates can be found in newspapers, money magazines and on the Internet. Compare rates of interest by using the AER (annual equivalent rate) to take account of the timing of interest payments. 92

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RETIREMENT PLANNING

Pension scheme contributions With current tax relief, for those on a marginal tax rate of 22%, a contribution of £100 only costs £78 (and for those on 40% only £60) and then earns income and capital gains free of tax (except that tax deducted from dividends can no longer be recovered). So pensions are a very tax-efficient investment. When a pension is drawn, it is taxed as income but in most cases some 25 % of the pension fund can be withdrawn as a tax-free lump sum. Contributions to the state pension schemes and occupational schemes are made from income. Personal and stakeholder pension contributions are also usually in the form of regular monthly payments but need not be. For self-employed people with irregular income, contributions in the form of a lump sum once a year, when you know how much is available, might be more appropriate. Furthermore, charges tend to be lower when contributions are made that way. Individual pension accounts With all forms of pension scheme apart from occupational final salary schemes, including stakeholder pensions for which they are specially designed, contributions can be paid into an individual pension account (IPA), which is a 'wrapper' like an ISA. The money can be invested in gilts, unit trust and shares in pooled investment funds and the advantage is that you have control over how the money is invested and can value your scheme at any time by looking up the value of the investments. If IPA holders change jobs and wish to join their new employer's scheme, they can either transfer the IPA into the new scheme or leave it where it is, stopping contributions to it as appropriate.

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AVCs

These additional voluntary contributions on top of an occupational scheme can also be made in the form of a lump sum and at present it is possible to go back to earlier years if there is space within the Inland Revenue limits on contributions. There is some debate about whether AVCs are better value than ISAs (see Chapter 7 for ISAs). With AVCs the contribution is tax-free but the benefit is taxable, whereas ISAs are the other way around. In both cases money in the scheme is free of tax on income and capital gains but ISAs have the advantage that tax deducted from dividends can be recovered until 2004. Charges might be higher for pension schemes than for ISAs. Most experts favour AVCs because the tax gain comes at the beginning and so funds accumulate tax-free at a higher level. The main advantage of ISAs is complete freedom of action - you can get your hands on the money at any time. However, some people prefer the discipline of not being able to access the funds before retirement. Cash lump sum on retirement

Most pension schemes include an option to take a cash lump sum on retirement. It is a pleasant decision to make, but it may not be easy. Remember you can choose to take as much as you like up to the scheme limit, but you lose pension in proportion. If a pension is fully inflation-proofed, then it might be better to keep it intact. If not, then it might be possible to buy an annuity with the cash which pays more after tax than the pension foregone, depending on annuity rates at the time. You do not have to buy an annuity; you may choose to invest the money differently. You may in any case want to use some cash to pay off some at least of your mortgage. But think carefully before using it for a holiday or a new car!

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Pension annuities With money-purchase occupational schemes, personal pensions and the new stakeholder pensions, the fund at retirement must be utilised to buy an annuity (this can be deferred in some cases beyond retirement). This is called a compulsory purchase annuity.and all the receipts are taxable (see Chapter 9 for more information on annuities). PROVIDING FOR SPECIAL EVENTS

These are usually saved for out of income but there is no reason why a lump sum cannot be used. Special events are normally short-term occurrences, so the money saved for them is usually put in a deposit account; if added to your emergency fund in the same account, a higher rate of interest may be obtained. If the event is more than three months away, a period notice account might earn more interest. If it is as much as over a year away, then a fixed-interest term deposit could be appropriate. A period in excess of three years opens up the possibility of National Savings or gilts but a minimum period of five years is recommended for an equity-based investment.

FINANCING YOUR CHILDREN'S EDUCATION This is another area where savings are normally made out of income but again a lump sum can be used. The object is to create income of a specified amount (plus inflation) for a specified future period. Take account of each child separately and, in the case of private schooling, do not commit your investment to a particular school. In this case, if you start early enough, an equity-based investment is worth considering, although as the due date gets nearer a gradual switch to fixed interest would be sensible.

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Place your investments in an ISA wrapper (see Chapter 7) if you are not already using your joint annual ISA allowance. In the case of fixed-interest, tax-free National Savings are worth considering if you are not already utilising your full allocations. Zeros (zero-dividend shares from a split fund - see Chapter 6) are often recommended, as they have a known repayment amount. They also have a known termination date, so a zero can be selected to fit in with your requirements. It is worth getting independent financial advice and there are specialists in this area. See Chapter 9 under investing in property for a way of financing university accommodation. DEALING WITH YOUR MORTGAGE

Using a lump sum to pay off your mortgage is low on the list of financial health priorities because interest rates on mortgages are lower than for other loans. However, the return you get in the form of interest saved is greater than you can get on any investment unless it is very risky, so it is in effect a sensible investment. There is some advantage in retaining a minimal mortgage because, should it be necessary to take one out in the future, it would make it easier to get and there would be fewer formalities. Also the lender will retain the deeds of the property, usually without charge, which can be convenient. If you have an endowment mortgage, do not surrender (cash in) the endowment policy as you will get a poor return. It is better to keep paying the premiums until maturity, the less satisfactory alternatives being to make the policy paid-up or to sell it on the second-hand endowment market.

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CASE SCENARIOS

Amanda starts a pension Amanda always felt this was something to be considered in the future but the financial health check has made her realise that she is losing the earlier years for fund growth. Furthermore, the tax allowances are good at her high marginal rate. Her employer doesn't have a scheme and in any case she changes her job frequently. She talks to an adviser, who directs her to the new stakeholder pension. She would make regular contributions with a lump sum top-up once a year, after she receives her bonus. Alistair and Jean think about university Alistair and Jean decide to put away some of the lump sum Jean inherited into a suitable long-term investment to produce amounts to help towards their children's university education. As this is a specialised area, they consult an adviser in the field. The adviser suggests putting some of the money into zeros with termination dates which coincide with each of the older two children's 18th birthday (not many years away), so that they know exactly how much will be available. In the case of the youngest child, the adviser recommends an equity-based investment as the time-scale is much longer. Gwen and Hugh discuss their mortgage Should Gwen and Hugh use some of the lump sum from the pension scheme to pay off their outstanding mortgage? They decide they will, because it would get rid of one financial worry. Also it would make it easier if they choose to move house later on. They decide to keep a minimum amount in order to get free security for their deeds and to make it easier if they need a mortgage again in the future.

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POINTS TO CONSIDER FURTHER

1. How do you rate investing in an AVC compared with an ISA? What are the relevant advantages and disadvantages? 2. If you have children, would you put money away to help meet the costs of further education or do you think they should learn to survive on students' loans and earnings from working in the holidays? 3. Where does using a lump sum to pay off your mortgage come in your order of priorities? Why could it be a good investment?

9 Specialised Investing BUYING ANNUITIES

As explained in Chapter 8, money-purchase, personal and stakeholder pensions must eventually be used to buy an annuity. This is called a compulsory purchase annuity (CPA) and all the proceeds are taxable. The tax-free lump sum from the pension scheme and any other lump sum can be used to buy an annuity. In this case it is called a purchased life annuity (PLA) and only the interest element of the proceeds is taxable (about half the proceeds are capital repayment). The provider of the annuity normally deducts tax at the standard rate of 22% so, if your marginal rate is higher or lower, you will have to pay the extra or claim a refund. Types of annuity There is a wide choice, including: Single life, the simplest type, which pays a flat rate over the remaining life of the annuitant. You need to remember that, even with inflation of only 3% a year, over 20 years the income will have fallen by 40% in real terms. Joint life, which continues until the second death of a couple, either at the same rate or a lower rate after the first death. Impaired life, where you get a higher amount because you have a terminal illness. Escalating, where the payout increases by a fixed percentage each year, but starts lower than a flat rate

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annuity. With an escalation rate of 3%, it takes some ten years for the payout to catch up and a further ten years to recover the shortfall over the first ten. Investment related, that is in a unit-linked or with-profits fund. Here the income will vary depending on performance, which may not suit you. (With-profits gives a smoother performance; unit-linked is more volatile.) In the case of with profits annuities, you usually have to choose a growth rate (called the hurdle rate) of between 0 and 5%. If the bonuses are consistently below the hurdle rate your income can fall, so it pays to choose a low rate. However, it is possible to get a with-profits annuity which gives a guarantee, such as that the payout will never fall below the starting amount, naturally at a lower starting figure. In choosing between flat rate and escalating, you need to think about how long you may live, taking into account your health and your family history of life expectation not an easy decision. There can be a wide variation in annuity rates, so it pays to shop around. Some newspapers show the best rates currently available for standard annuities. (See Figure 12 for examples of current annuity rates.) The most important thing to remember about an annuity is that it usually dies with you, so there is nothing left to pass on to your heirs, although it is possible to arrange for some at least of the capital sum to be preserved, again obviously at a lower starting payout. Annuity Direct have a guide to pension income, which includes annuities - ring 08450 756 550. INVESTING FOR CHILDREN

It is possible for children to have investments in National Savings (and there is a special account for them, children's bonus bonds - see Chapter 3), and bank and building

Specialised Investing 101

Purchased life annuities (bought with your own money, including tax-free cash from a pension scheme). Income tax is deductible only from the income portion of the payment, the capital repayment element being free of tax. The rates shown are flat rates after deducting 20% tax from the income element.

Single life, starting age: 55 60 65

Male %

Female %

6.4 7.2 8.2

5.8 6.4 7.3

Joint life, starting age: husband 60/wife 57 husband 65/wife 63

% 6.3 7.1

Compulsory purchase annuities (those which you eventually have to buy with most of the funds from a money-purchase type pension scheme). Income tax is deductible from the whole payment. The rates shown are flat rates before deducting tax, with a 50% spouse's benefit where applicable. Male %

Female %

5.9 6.5 7.4

5.7 6.1 6.8

Single life, starting age:

55 60 65 Joint life, starting age: husband 60/wife 57 husband 65/wife 63

% 5.9 6.6

Note: These rates were among the best available at the time of going to press. They change daily (unfortunately generally downwards). Current rates can be found in newspapers.

Fig. 12. Examples of annuity rates.

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society accounts. Below the age of seven, they cannot operate these accounts themselves, but someone (usually a parent) can act for them. Children are entitled to the personal tax allowances. However, if the parents have provided the capital, then income of over £100 a year for each parent is treated as their income and is taxed accordingly. This does not, though, apply to anyone else; in particular grandparents can give their grandchildren as much as they choose (subject to inheritance tax restrictions - see Chapter 10) without the income being treated as theirs. Inland Revenue form R85 can be submitted to arrange for interest to be paid gross if there is no tax liability. Because investing by children is frequently of a long-term nature, equity investment is highly appropriate, particularly pooled investments such as unit trusts, investment trusts and friendly society bonds. Tax deducted at source from dividends cannot of course be recovered. The normal capital gains tax allowances apply. Children under the age of 18 cannot sign documents of title, so the usual basis is for an adult to act as bare trustee, shares or units being registered in the name of the adult with the addition of the child's initials. To make the position quite clear, it is a good idea to leave with your will a note explaining the ownership of the investment. See Appendix B under investment trusts and unit trusts for leaflets from the AITC and AUTIF and under National Savings for the leaflet on children's bonus bonds. Baby bonds

There is a proposal to introduce, possibly in the year 2003, the Child Trust Fund, or baby bond. At birth, children will be allocated a sum of £250 (£500 for poorer families) from public funds. Further amounts of £100 (£200 for poorer families) will be added at the ages of 5,11 and 16. Funds will grow tax-free. Rules about the usage of funds have yet to be agreed, but they will be restricted to such matters as education or

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mortgage downpayments and will not become available for use until age 18 or 21. There may be an arrangement for parents (or others, such as grandparents) to make matching contributions, including the possibility of transfers from savings under the proposed Savings Gateway (see Chapter 3). MAKING ETHICAL INVESTMENTS

Ethical or green investments are made in companies which do not pollute, do not make or supply arms and respect the environment and/or ethical issues. Investment and unit trusts have ethical funds. It is questionable whether the limitation on investment adversely affects income/growth although logic says it must. The counter-argument is that unethical companies suffer from government interference, sooner or later, so perform less well in the long run. Certainly some ethical funds have a good record of performance. Ethical funds generally follow one of two approaches, either positive screening by selecting companies which provide an ethical benefit such as supporting charities out of profits, or negative screening which leaves out companies which are involved in 'unethical' businesses such as gambling. There are advisers and stockbrokers who specialise in ethical investing and EIRIS (ring 0845 606 0324) provides lists. A free guide can be obtained from the Ethical Investment Association, c/o Ethical Investment Services, 33 Ribblesdale Place, Preston PR1 3NA. INVESTING BY THE ELDERLY

Conventional wisdom says that the elderly should reduce their equity holdings as the years roll on. The main reason for this is that the shorter the period of investment the more likelihood there is of suffering a loss from a stock market fall.

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However, there may not the same need to realise investments as there is in respect of pension schemes and returns on equities average much more than on fixed interest. Income from equities can be lower than on fixed interest but if more income is desired it can be achieved by realising capital gains and, if the gains are within the annual exempt amount, the gains are free of tax. It is the total return that matters. The only time that total returns on equities can be beaten is when you reach an age where an annuity provides greater income. Even then, the loss of the capital must be taken into account because you may wish to retain the capital to pass on to your descendants. INVESTING IN PROPERTY

Property tends to grow in value like equities and so is a good long-term investment. The biggest investment you can make in property is owning your own house. Some experts say this is enough exposure to the property sector. Indirect investment in property can be achieved through companies whose business is investing in property, usually commercial property, or via pooled investments in property such as unit trusts and investment trusts. Buy to let Further direct investment in property - buying to let for example - is a specialised area of investment which can be yield both income and capital gain. It has become increasingly popular in recent years as the demand for rented property has increased (and may continue to increase with people living longer and the trend towards more single-parent families) and it can be a way of using the lump sum from your pension scheme on retirement to provide additional income - and something to keep you busy!

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Most buyers to let take out a mortgage and there special mortgages available, based on the rent you can charge rather than your income, so that only part of the cost needs to be put up (perhaps no more than 20%). Mortgage interest and other expenses can be set against income for income tax purposes. For a higher cost, a manager can be appointed to take away some of the work and worry. There are risks in direct ownership, such as not being able to find a tenant, rent not being paid and damage to the property. Provision for these events and for the cost of repairs should be made when calculating the viability of the investment. There are legal expenses, too. You need to take care in choosing a suitable area and size of property (number of bedrooms). Do not fall into the trap of choosing a place merely because you like it. Using an unapproved pension scheme A more sophisticated version of buy to let, suitable for higher-rate taxpayers, is to finance the purchase through a funded unapproved pension scheme (FURBS) in a company which you set up for the purpose. The pension scheme buys the property and your pension contributions finance the mortgage repayments. There are significant tax advantages: profits are taxed at the favourable small company rate of 22%; the company pays a lower rate of capital gains tax (34%); inheritance tax is avoided as the property passes to your heirs from the company and so stays out of your estate. There are substantial costs involved in setting up the arrangements, so this method is only suitable for people who can finance a large property portfolio.

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University accommodation A particular area of buying to let arises if you have a child going to university. It may well be worth finding a property near the university and arranging for your child to buy it, by loaning the deposit and if necessary acting as guarantor for the mortgage. The primary 'income' is the saving through not paying rent but the property needs to be large enough to let out rooms to other students, thus providing an income against which the costs can be set for tax purposes, bearing in mind that a child has the income tax personal allowance, so income tax should not be payable. If the child's income exceeds the income tax personal allowance, the 'rent-a-room' tax relief will also apply whereby if a room is let for less then £4,250 a year, the income is tax-free (There is an Inland Revenue leaflet explaining this - see Appendix B.) At the end of the course, the property can be sold, the mortgage and your loan repaid and hopefully a capital gain made, which your child can save or use as a deposit on a further home. It would be subject to capital gains tax, but this would be reduced or eliminated by taper relief and the annnual exempt amount - see Chapter 10. Investing in ground rents

Ground rents are paid by leaseholders to the owner of the freehold of a property. So investing in ground rents means buying the freehold of such properties. There are two types: those which pay a reasonable income; and those which have a very low income but are expected to show capital growth. Freeholds are available for houses and flats and for commercial premises such as shops and there is a wide variety of prices. Those where the leaseholders are responsible for maintenance and insurance (usually

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commercial premises) are less troublesome. Leaseholders rarely fail to pay ground rent because the consequences for them might be drastic - the freeholder can sue for repossession. Therefore the income should be steady and around 10% before tax is achievable. Capital growth freeholds usually have a relatively short period to run before the lease expires and the freeholder is hoping that the leaseholder will then wish to buy the freehold - at what is called the marriage value. Freeholds are usually sold at auctions and the income is set, so the return is easily calculable. There may be rent reviews at intervals in the remaining life of the lease. It is possible to get a mortgage for buying a freehold, but it needs to be of the income type so that money is forthcoming to pay the interest on the loan. Borrowing to invest for growth is more risky. COLLECTING

This heading refers to the purchase of assets which it is hoped will increase in value, such as antique furniture and paintings. The disadvantage of 'collectibles', as they are sometimes called, is that they produce no income - all the return is in the potential increase in value and that value is usually subject to fashion and whims. On the other hand, it can be argued that they give pleasure - that is the return. Collectibles can be damaged or stolen, so they must be insured at current replacement value, which means getting regular valuations: these can cost around 1 % of value each time. It is also a good idea to keep coloured photographs and written descriptions. In the event of a dispute about value, you can get help from the appropriate trade association. Buying and selling at auctions involves the payment of high commissions (buyers 15%, perhaps, and sellers 10%).

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Buying in a shop avoids commission, but how far can you trust them to buy and sell at accurate values? For all collectibles, you do need to be aware of value and you should not buy for investment unless you have a lot of knowledge of your chosen category. Art and antiques A London art dealer recently said that art has not kept pace with conventional investment over the last 20 years. Sothebys have an art index which shows changes in value over 1, 2, 5 and 10 years, by category (paintings, ceramics, furniture, silver). Classic or vintage cars Classic cars are post-1939, over 20 years old. Vintage cars are pre-1939. As on all cars, capital gains are not taxable and compared with ordinary cars there should be no depreciation. Insurance may be difficult and you probably need to be a mechanic as repairs are expensive. It might be possible to earn some income by hiring out, for example for weddings. Stamps Most serious collectors specialise. A good collection can be assembled for £2,000. Low value stamps tend to stay low in value - only expensive ones appreciate. British sets currently issued are valued at only 80% of face value so are not a good investment. If you are selling a collection of stamps, perhaps inherited, and they are muddled, do not try to sort them out first as they are more exciting to an enthusiast in their mixed up state and so of more value. Wine The most established markets are vintage ports and Burgundy and Bordeaux wines.

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You can start with as little as £500, which will buy three cases (12 bottles to a case) at around £150 each, but you must be prepared to keep them for a long time. Better to start by using a dealer rather than bidding at an auction. You can of course make a larger investment to start with, intending to drink some, sell some and buy some more, but try to drink your loss items rather than the profitable ones! Value is greater if bought and kept 'in bond' as duty and VAT are not paid. Storage costs about £5 a year for each case. Consider buying Parker's Wine Buyers Guide (£30) and/or subscribing to their newsletter, The Wine Advocate. MAKING THE MOST OF REDUNDANCY PAY

If you are made redundant you should receive a lump sum compensation payment, some or all of which is tax-free and which needs to be invested. Most people need to use their redundancy payment to live on while looking for another job. In those circumstances, an instant-access deposit account is the only sensible investment. You may be fortunate enough to get compensation beyond the tax-free amount. If you can afford to forgo some of the taxable compensation, consider asking your employer to use it to buy extra pension for you. As you do not receive the money, it is not taxable on you and employer contributions to a company pension scheme are not limited. Another possibility is to invest part at least of your compensation in a new business of your own, if you think the prospects of success are better than finding another job.

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CASE SCENARIOS Amanda buys a flat

It is time Amanda entered the property market, her friends tell her. She is very happy in her flat and there is no opportunity to buy it. So she considers buying another flat to let. She carefully picks an area which is said to be 'going up' and gets details from estate agents in the area. She doesn't have time to manage it herself, so she reviews the estate agents with a view to appointing one as manager. She does her sums and finds that she can make a profit after expenses providing she has a tenant for at least ten months of the year, so she decides to go ahead with the investment. In addition, she hopes for some capital gain. Alistair and Jean

Alistair and Jean consider putting some of the inherited lump sum into savings accounts for the children, to introduce them to saving and money care. They know about the tax liability if annual interest exceeds £100 each for each child, so they calculate the maximum lump sum accordingly. Later they will consider pooled equity investments, recognising that these could give better returns over the long term. Gwen goes green

Gwen reads in a wildlife magazine that there are companies which are recognised as complying with environmental standards and suggests to Hugh that some at least of their future investments should be in such companies. Hugh is sceptical, pointing out the risk of inadequate performance, but Gwen gets hold of a list of ethical investments and picks out some unit trusts that have a good record, so Hugh agrees to give one of them a try.

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POINTS TO CONSIDER FURTHER

1. Have you got some surplus funds which could be channelled into investments for your children or grandchildren? If so, what do you consider the best investment? 2. If as a shareholder you consider that a company has been unethical in some way, what do you do? Write a letter of complaint to the chairman? Go along to the next AGM and raise the issue? Just sell the shares? Which do you think would have the most impact? 3. Assuming you own your own home, how do you feel about further property investment? In particular, would you consider buying to let? What are the risks? Would you have time to manage it yourself?

10 Reducing Tax on Investments ATTACKING YOUR INVESTMENT INCOME TAX BILL

Investment income is treated as the top slice of income so that the allowances and lower rate bands are used against earned income first and against income from savings before dividends. See Figure 13 for current income tax data. Allowance Personal Higher amount if aged 65-74 75 and over

£4,535 £5,990 £6,260

Income limit for age allowance £17,600 (above which the extra allowance is cut back on the basis of £1 for every extra £2). Married couples (limited to 10%) aged 65 to 74 aged 75 and over

£5,365 £5,435

Similar income, limit and cut back as for personal allowance, down to a minimum of £2,070, but only after personal allowance fully cut back. Blind persons

£1,450

Rates: Lower rate band Baic rate band Higher rate band

10% 22% 40%

Up to £1,880 £1,881 to £29,400 Over £29,0400

Fig. 13. Current income tax data.

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Investment income is taxed at 20% unless your total income for the year enters the 40% band. Then a further 20% is payable on any income in that band from which 20% has been deducted at source. If total income for the year is below the 20% band, investment income is taxed at 10% and if it is below the 10% band it is is tax-free. Tax deducted at source at 20% can be recovered. Tax is deducted from bank and building society interest at the rate of 20% before it is paid, unless recipients have completed a form (obtainable from the bank or building society) saying that their total income is below their total allowances. Dividends on shares are treated as having been taxed at source at 10% (this is sometimes called the dividend tax credit). It cannot be avoided and cannot be recovered by a non-taxpayer. Higher-rate taxpayers must pay a further 32.5%. Investments can be transferred between spouses to take advantage of one having lower income tax rates than the other, without incurring capital gains or inheritance tax liabilities, or stamp duty. Investments free of income tax Income from the following investments is free of tax: National Savings certificates, children's bonus bonds and premium bonds ISAs and PEPs TESSAs (till maturity) friendly society savings schemes venture capital trusts commercial forestry Tax relief on amount invested There are also certain investments which earn income tax

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relief on the amount invested. The relief would be at your highest tax rate. They are: pension scheme contributions within Inland Revenue limits new enterprise investment schemes and venture capital trusts. MINIMISING CAPITAL GAINS TAX

Capital gains tax (CGT) is payable on the sale not only of stocks and shares but also of anything other than household goods and personal effects up to the value of £6,000 and private motor vehicles. Subject to certain exceptions, you do not pay CGT on any gain you make when you sell your home. Nor, on the other hand, can you set off any loss against gains made elsewhere. Capital losses are set off against capital gains in the same tax year and after that there is an annual exemption, currently £7,500. As a result, few people pay CGT. If the net result of a year's transactions before the annual exemption is a loss, it can be carried forward to succeeding years. The annual exemption cannot be carried forward, but can be applied to the net gains for a year before any loss brought forward which, if not then used, can be carried forward again. The following investments are exempt from CGT: gilt-edged stock company debentures and loan stocks friendly society savings schemes ISAs and PEPs company share option schemes enterprise investment schemes and venture capital trusts

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commercial forestry. As with tax on income, investments which are free of capital gains tax need to be good investments in their own right. A taxed gain is better than no gain at all. Indexation and taper relief For purchases before April 1998 the cost can be indexed, that is adjusted by the cumulative rate of inflation (RPI) between purchase and April 1998. However, indexation cannot be taken beyond breakeven, i.e. it cannot be used to create a loss. If you held any shares before 6 April 1998, it is a good idea to calculate the indexed cost now, as it will not change. This can be done by using the CGT indexation allowances for April 1998, available in Inland Revenue leaflet CGT1, which can be obtained from your local tax office. From April 1998, indexation was replaced by taper relief which is based on the length of ownership. It only applies to shares held for at least three complete years, although an extra year is added to the total for shares owned on 17 March 1998. The percentage of the gain chargeable reduces to 95% after the third complete year and by a further 5% for each successive year, to a minimum of 60% after ten complete years. For example, if you bought shares in August 1996 and sold them in June 2001, the taxable gain would be calculated as follows: The original cost would be increased to 5 April 1998 in accordance with the CGT indexation allowance for the period, to give the indexed cost. The excess of the selling value over the indexed cost gives the taxable gain before taper relief. Although the shares have only been held for two full years since April 1998, as the shares were held on 17

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March 1998 an extra year is added, making a total of three years, so taper relief reduces the chargeable gain to 95%. More favourable taper relief applies to business assets, and since 6 April 2000 it also applies to all shares owned in your employing company and to all shares in unquoted and AIM quoted companies. The percentage of the gain chargeable in this case reduces to 87.5% after the first complete year, to 75% after two years and 50% after three, to a minimum of 25% after four years. The amounts are shown in full detail in Figure 14. Gains on non-business assets Gains on business assets Number of complete years after 5.4.98 for which asset held

0 1 2 3 4 5 6 7 8 9 10 or more

Percentage of gain chargeable

Percentage Equivalent Equivalent of gain rates for tax rates for higher chargeable higher rate/basic rate/basic rate taxpayer rate taxpayer

100 100 100 95 90 85 80 75 70 65 60

40/22.00 40/22.00 40/22.00 38/20.9 36/19.8 34/18.7 32/17.6 30/16.5 28/15.4 26/14.3 24/13.2

100 87.5 75 50 25

40/22 35/19.25 30/16.5

20/11

10/5.5

An extra year is added to the taper relief score for all non-business assets held on 17 March 1998, so for such assets the three-year period is already up and taper relief can be applied.

Fig. 14. Capital gains tax taper relief.

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Where shares qualify as business assets only from 6 April 2000, the gain for shares owned on that date has to be apportioned between the two periods. Calculating the taxable gain

The method of calculating the chargeable capital gain, following the introduction of taper relief, is shown in Figure 15. An example of a taxable capital gains calculation is shown in Figure 16. The complications of indexation and taper relief can be ignored if your gross gains for a year do not exceed the annual exemption, currently £7,500. Reinvestment relief

Chargeable gains on disposals can be deferred indefinitely if the amounts realised are reinvested in new share issues from qualifying companies under the Enterprise Investment Scheme (see Chapter 6). Tax payable

The net chargeable gain for the year is added to your income and is taxed at 10% if any falls within the personal allowance or the 10% band, at 20% for any within the basic rate band (not 22% as for income) and 40% thereafter. CGT liability cannot be set against personal allowances. Annual planning

This is mainly a matter of ensuring you make use of your annual tax-free allowance. You should keep a running record of your sales during each financial year (starting 6 April), with a note of the gain or loss, after adjusting for indexation and taper relief. Check on the cumulative position at the beginning of March. If you have a substantial amount of your annual allowance still available, then take a look at the unrealised gains in your portfolio.

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New method of calculating the chargeable capital gain, introduced in the March 1998 Budget: 1. Calculate the indexed cost to 5 April 1998. (It will be worth doing these calculations in advance for all shares held on that date.) 2. Calculate the gain or loss after indexation on each sale. (Indexation cannot be used to create a loss.) 3. List all the gains for the year in ascending order of complete years held after 5 April 1998. An extra year is added to all holdings on 17 March 1998. 4. Set any losses in the current year against the individual gains, starting with those held for the least number of years (because this produces the lowest tax charge). 5. Apply taper relief as appropriate to each remaining gain (the earliest this can apply is after 5 April 2000 and then only to shares held on 17 March 1998). 6. Total the net gains for the year, after indexation and taper relief, and deduct the annual exempt amount (£7,500 in 2001), to arrive at the net chargeable gain for the year. 7. If you have any losses brought forward from the previous year, they are used to reduce the net chargeable gain, but in order to do this you have to go back to 4 above, as losses must be applied before taper relief. As in 4 above, the losses should be set against the individual gains on shares which have been held for the shortest period, to get the maximum benefit from taper relief. But in this case leave sufficient gains after taper relief to utilise the full annual exempt amount. 8. Any losses brought forward but not used are carried forward to the following year. Partial sales Where a partial sale of a holding takes place, the shares sold are identified in the following order: 1. Same day purchase and sale. 2. Sale within 30 days of purchase. 3. Previous purchases since 5 April 1998, the most recent first. 4. Purchases between 6 April 1982 and 5 April 1998.* 5. Purchases between 6 April 1965 and 5 April 1982.* 6. Purchases before 6 April 1965.* 'These are treated as pools, with average costs per share.

Fig. 15. The new method of calculating the chargeable capital gain.

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Transaction record

Monthly CGTI*

17.1.95 Bought 1,000 shares at 21 Op each Commision £20, stamp duty £10 28.6.96 Bonus issue of 1 new share for each existing share held 4.10.97 Rights issue of 1 for 2 at 200p 11.2.98 Scrip dividend taken of 100 shares at 220p each 12.4.99 Sold 1,000 shares for 271 p each Commission £20

0.114 0.063 0.019 0.014

"Index numbers are taken from the monthly table of capital gains tax indexation allowances for April 1998. Calculation - indexation relief Original cost £2,100 + £20 + £10 = £2,130 The bonus issue is ignored as no cost is involved, but the number of shares doubles to 2,000. Index to Oct. 97: 0.114-0.019 = 0.095 £2,130 x 1.095 Add: rights issue cost 1,000 x £2 Indexed cost of 3,000 shares

£ = 2,332 = 2,000 4,332

Index to Feb. 98: 0.019-0.014 = 0.005 £4,332 x 1.005 Add: scrip dividend cost 100 x £2,.20 Index cost of 3,100 shares Indexed cost to April 98t; £4,573 x 1.014

£ = 4,353 = 220 4,573 = 4,637

Indexed cost of 1,000 shares = £4,637 x 1,000/3,100 Net sale proceeds 1,000 x £2.71 - £20 Taxable gain before taper relief

£ = 1,495 = 2,690 1,195

tApril 1998 is the final month for indexation. Calculation - taper relief Complete years shares held after 6.4.98 = 2 Add 1 year as shares were held on 17.3.98 = 1 Total years for taper relief Taper relief for 3 years = 5%

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3

Taxable gain reduced by 5% to £1,135

Fig. 16. Example of a taxable capital gains calculation.

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Bed and breakfasting

Before 17 March 1998, any unused annual allowance could be applied to unrealised gains before the end of the tax year by selling the shares one day and buying them back the next. This has been stopped by introducing a minimum 30 day interval between selling and buying back, otherwise the two transactions will be ignored for CGT purposes. It is of course possible to take the risk of being out of the market for 30 days. Other alternatives are: If you have not used all your current year's ISA allowance or have uninvested amounts in a PEP, then you can 'bed and ISA' or 'bed and PEP', that is buy back into an ISA or PEP. If you are married you can sell and your spouse buy back (or vice versa). You can buy a similar share (e.g. BP for Shell) or your best choice of new investment. In all these alternatives the sale and buy-back can be done simultaneously, so there is no risk of adverse price movement overnight. The disadvantage is that costs of both selling and buying (including stamp duty) are incurred, although some stockbrokers will forgo some or all of their commission on the second transaction. Also you lose the difference between the buying and selling prices. AVOIDING INHERITANCE TAX

Inheritance tax (IHT) is normally payable on death but can be partly payable earlier. It is also sometimes called a voluntary tax because there are so many ways of avoiding it. However, they are not straightforward.

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Investments free of IHT Provided you have invested for at least two years, the following are exempt: investments in AIM and unquoted shares (these can be invested via unit and investment trusts) commercial forestry assets connected to Lloyds of London. Making gifts during your lifetime Inheritance tax (IHT) may be payable on gifts you make before your death but, if you can afford it, there are a number you can make free of IHT. Of particular importance are the £3,000 annual exemption (higher amounts on marriage) and the unlimited number of gifts of £250 to any one person. Figure 17 shows details of the lifetime gifts which are exempt from IHT. PETs, ICTs and taper relief Gifts to individuals or certain trusts not otherwise exempt are potentially exempt transfers (PETs). Tax is avoided if you live for seven years thereafter but if not it may be payable on your death. Gifts to companies or discretionary trusts are called immediately chargeable transfers (ICTs) and half the IHT rate of 40% is payable immediately. The balance may become payable if you die within seven years but if no tax is due then you cannot recover what has been paid. When PETs and ICTs within seven years of death are included in an estate, they are first set against the threshold in chronological order. If their total exceeds the threshold then the relevant donees (the recipients of the gifts), not the estate, are responsible for paying the IHT on them. If the period since the excess amounts were paid is more than three years, then taper relief applies. Tax on the

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The following transfers are exempt from IHT: transfers between spouses; £3,000 payment from capital (this is an annual exemption which can be carried forward one year but no longer; small gifts not exceeding £250 each, without limit in number, but only if you have not also given them any of the other exempt gifts in the same year; a series of regular gifts from surplus income, but there must be no reduction in capital nor in the standard of living of the donor (the taxpayer must be able to show that these requirements are met); gifts relating to marriage: - up to £5,000 from each parent; - up to £2,500 to a direct descendant (e.g. a grandchild); - up to £1,000 to anyone else; gifts for maintenance of the family (this applies to spouse and children up to age 18 or until completion of full-time education; gifts to charities, museums and political parties; gifts of investments in unquoted securities, including investments in the alternative investment market (AIM), which have been held for more than two years. You can make gifts to the same person under any of the above headings in the same year without incurring IHT, except the small gifts of £250 each. So, for example, you can give your child a wedding gift of £5,000 plus £3,000 (plus another £3,000 if you did not use it last year).

Fig. 17. Lifetime transfers exempt from inheritance tax.

relevant amounts is reduced to 80% of the full charge (i.e. 32% tax) in the fourth year, 60% of it (24%) in the fifth year, 40% (16%) in the sixth year and 20% (8%) in the seventh year. In the case of ICTs, tax already paid is deducted from the tax due but cannot be used to create a refund.

Mary, a rich widow, puts £150,000 into a discretionary trust for her family, on 31.12.94. This was an ICT (immediately chargeable transfer) but as this was her first transfer and was within the threshold then - also £150,000 - no inheritance tax was payable. Two years later she gives assets worth £50,000 each to her son and daughter. These were PETs (potentially exempt transfers) so no tax was payable. Mary died on 1.3.98. (The threshold had by then gone up to £215,000.) All the above transfers fall into the seven-year period before her death and so are liable for tax. They are set against the threshold in chronological order, as follows: Threshold 31.12.94 ICT Balance 31.12.96 PETs Taxable PETs

£215,000 £150,000 £65,000 £100,000 £35,000

(The rest of the estate is ignored for the purpose of this example.) As less than three years have passed, taper relief does not apply. However, if Mary had made the two PETs earlier, say between 1.1.95 and 28.2.95, three years would have passed, so the tax payable on the £35,000 would have been reduced by taper relief to 80% of 40%, i.e. to 32% saving 8% of £35,000 What if the £100,000 on 31.12.96 had also been paid into the discretionary trust? The threshold had by then increased to £200,000 but tax would have been immediately payable, as follows: Total payments within 7 years Threshold Taxable ICT

£250,000 £200,000 £50,000

Tax at half the death rate, i.e. 20% = £10,000 On Mary's death, when the threshold had gone up to £215,000, a further 20% would have been payable on £250,000-E215,000 = £35,000, i.e. £7,000. If Mary had lived another two years, say (and assuming for simplicity no further change in the threshold), then the tax payable would have been reduced by taper relief to 80% of 40%, i.e. 32%. The 20% already paid would be deducted, leaving 12% to pay on the £35,000, i.e. £4,200. If she had lived a further four years (and still assuming no change in the threshold), no extra tax would have been payable, as taper relief would have reduced the tax payable to 40% of 40%, i.e. 16%, and, as 20% would have already been paid, no further tax would be payable. But refunds are not permitted, so there would be no recovery of the 4% overpayment.

Fig. 18. Example of how immediately chargeable transfers, potentially exempt transfers and IHT taper relief work.

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Tax payable on death

Amounts left to your spouse are free of IHT and most couples leave everything to each other, but this may not be the best solution. The first £242,000 of taxable estate (the current exempt amount or threshold) is free of tax. It sounds a lot but with house values now so high tax may be payable. Beyond the threshold the tax rate is 40%. PETs and ICTs made within seven years of your death are counted in order of payment and so are set against the threshold first. There is taper relief from the fourth year but it only applies to amounts which exceed the threshold. See Figure 18 for an example of how ICTs, PETs and taper relief work. Paying IHT

It must be paid before grant of probate (official permission for executors to act) but assets cannot be sold before getting probate, so it may be necessary for the executor(s) to borrow. If the estate includes property, it is possible to defer payment of the proportion of IHT payable equal to the proportion of the property value to the whole estate. Some banks and building societies will release cash from the deceased person's account for the purpose of paying IHT. Certain investments which include life cover, such as with-profits bonds, although subject to IHT, can be written into trust so that they pass directly to your heirs and can then be realised to meet some at least of the tax bill. Estate planning

So far as planning is concerned, the importance of making a will cannot be overstressed. Otherwise, intestacy rules apply, which may not suit you. If a married couple's joint estate may exceed the threshold they need to find a way of using the exempt amount on the first death. The problem usually is that the

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survivor cannot manage without the assets, particularly the house. There are ways in which this problem can be overcome but they need to be watertight so the use of a solicitor experienced in IHT planning is essential. Usually a trust is set up to come into operation on the first death and receive assets up to the exempt amount. It is possible for the surviving spouse to be a beneficiary. If all the beneficiaries agree, a will can be changed within two years of the death - this is called a deed of variation. If you know that IHT will be payable, make some provision for it, such as life assurance. For a married couple, a joint life second death policy can be taken out, written into trust for the beneficiaries so that it escapes the IHT net. Check whether your bank/building society deposits will be released. TAX-EFFICIENT INVESTING

Details of tax-efficient investments have been given above under the relevant tax heading. Make the most of the opportunities for tax-efficient investing, particularly if you are a higher-rate taxpayer, but do not make such an investment just because it is tax-free it must be worthwhile in itself. INVESTING AS A NON-TAXPAYER

A non-taxpayer needs to look at returns on a pre-tax basis and avoid investments where the interest or dividend is paid after tax is deducted and the tax cannot be recovered. Tax-free investments are not necessarily advantageous to the non-taxpayer; taxable investments on which the tax can be avoided or recovered might offer a better return. Tax is deducted from bank and building society interest at 20% before it is paid but non-taxpayers can arrange to

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receive it gross by completing a form obtainable from the provider stating that their total income is below the personal allowance. CASE SCENARIOS Amanda becomes adventurous

Amanda thinks about other tax-efficient investments, having already invested in a venture capital trust. She considers National Savings certificates and decides to put the maximum amount of £10,000 into the index-linked version because she likes the idea of an inflation-protected income. She also decides to have a 'gamble' on Premium Bonds and thinks about putting in the maximum of £20,000 to maximise her chances of winning. Alistair and Jean do a bed and ISA

Alistair has potential capital gains in excess of the current year's allowance, which he wishes to realise, although he would like to retain an investment in a unit trust which has done particularly well and there is every reason why the success should continue. Instead of waiting till next year, they decide to bed and ISA the unit trust, i.e. for Alistair to sell and both to buy back into their maxi-ISAs the same day, so that there is no risk of adverse market movement. They contact the unit trust manager, who is prepared to forgo the initial charge on repurchase, making it an even better deal. Gwen and Hugh minimise inheritance tax

Their house less remaining mortgage is worth about £170,000. Investments total £100,000 and other assets about £30,000, making a total of about £300,000, much more than the exempt amount. As they want to minimise IHT they have to do something on the first death but need the investments to

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provide an income. This means doing something about the house, which they own jointly. They consult a solicitor who recommends first writing a simple letter turning their ownership into tenants-in-common, which gives them more freedom of action and then changing their wills so that they each leave half the house to a family trust. They give this some thought, recognising that the survivor will share ownership with the trust. Are their children likely to force them out? What happens if the survivor wishes to move to smaller accommodation? POINTS TO CONSIDER FURTHER

1. Is it better for non-taxpayers to get interest paid gross than to wait till the year end before tax deducted can be recovered? If so, why? 2. Avoiding tax on income and/or capital gains is an attractive proposition but the saving needs to exceed any additional cost. How do you work this out, in each case? 3. If you are in a position where inheritance tax will be payable on your estate, have you considered taking action to avoid it? If you are married, what is the most important step you should take?

Appendix A General Reading, Listening, Viewing and Surfing BOOKS Beginner's Guide to Investment, Bernard Gray (Century Business, £14.99). Investing in Stocks and Shares, John White (How To Books, £9.99). Making Your Money Work for You, Simon Collins (How To Books, £9.99). Saving and Investing, John Whiteley (How To Books, £9.99). Which? Way to Save and Invest (£14.99). NEWSPAPERS AND MAGAZINES Financial Times (Saturday edition has more price details than other days). Investors Chronicle (weekly). Money Observer (monthly). Money wise (monthly). What Investment (monthly). Other newspapers - many have personal finance sections, especially on Sundays. RADIO Moneybox: Radio 4, Saturdays at 12 noon. Moneybox Live, Radio 4, Mondays at 3pm.

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Appendix A

TELEVISION

There are occasional series on money matters, e.g. Pound for Pound, BBC 2. Serious Money, Channel 5. Your Money or Your Life, BBC 2. Consumer programmes which sometimes include investment matters: The Money Programme, BBC 2. Watchdog, BBC 1, Thursdays 7pm. Other money and consumer programmes on any channel. Ceefax and Teletext: share prices, currencies and much more investment information, including some selling of investments on Teletext. INTERNET

If you have a connection to the Internet there is a great deal of information available. All the main providers of investment products have websites and in addition there are bulletin boards on investment matters and discussion groups you can join. There are some useful general investment websites, including: www.fool.co.uk www. thisismoney. com www.ftmarketwa tch. com www. money facts, co. uk www. moneysupermarket. com

129

Appendix B How to Get Further Information and Advice Note: These days almost all the organisations listed below have websites. If you have a connection to the Internet you should be able to find a site using a search engine and the relevant name. INVESTMENT ADVICE Useful free guides can be obtained from: Help the Aged, 0800 650 065: Managing a Lump Sum. Towry Law, (08457) 88 99 33: Guide to Retirement Planning. For a list of independent financial advisers (IFAs) in your area, phone IFA Promotions on (0117) 971 1177. For a list of fee-based IFAs phone Money Management Register on (0117) 976 9444. Chase de Vere's Moneyline (0800 526 091) provides lists of best interest rates. INVESTMENT TRUSTS Information can be obtained from the AITC (Association of Investment Trust Companies), Durrant House, 8-13 Chiswell Street, London EC1Y 4YY. Tel: (020) 7431 5222.

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Appendix B 131

NATIONAL SAVINGS Leaflets about each product and a separate leaflet showing current interest rates are available in post offices. Current interest rates can be found on Ceefax on Channel 2 under Savings. SHARE PRICES Most newspapers carry some share prices. The Saturday Financial Times has the most complete list. For price movements during the day, see Ceefax or Teletext, although their listings are somewhat limited. There are telephone systems, e.g. Cityline (020) 7247 7080, but they tend to be expensive. There are also Internet services, e.g. www.hemscott.net. STOCKBROKERS The APCIMS (Association of Private Client Investment Managers and Stockbrokers) will send a list of stockbrokers showing some information about each. Rin^ (020) 7247 7080. TAX

For Inland Revenue leaflets on income and capital gains tax contact your local tax office - see telephone book. They will post them to you. You can get a catalogue of leaflets. Useful ones are: CGT1 IR87 IR95 IR97 IR101 IR110 ISA/1

Capital gains tax - an introduction Letting and your home Profit-sharing schemes SA YE share option schemes Company share option schemes Guide for people with savings The answers to ISAs

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For booklets on inheritance tax contact the Capital Taxes Office. Ring (0115) 974 2400. UNIT TRUSTS

Information can be obtained from AUTIF (Association of Unit Trusts and Investment Funds). Ring (020) 7831 0898.

Appendix C How to Complain BANKS AND BUILDING SOCIETIES

First complain to your own branch. Then take it to the head office. Finally write to the appropriate ombudsman: The Banking Ombudsman, 70 Gray's Inn Road, London WC1X 8NB. Tel: 08457 660 902. The Building Society Ombudsman, Millbank Tower, London SW1P 4QP. Tel: (020) 7931 0044. INVESTMENT

Complain to your adviser first. The overall authority is the FOS (Financial Ombudsman Service), which supervises and will be taking over several self-regulatory bodies, i.e. IMRO, PIA, SFA (see below). If in doubt as to which applies, contact the FSA Central Register (ring 08456 061 234) and they will tell you. The address for the FOS and all the other bodies is: South Quay Plaza, 183, Marsh Wall, London E14 9SR. There is an investment compensation scheme if a regulated business goes under - the first £30,000 plus 90% of the next £20,000 is covered. Investment managers and advisers are covered by IMRO (Investment Managers Regulatory Organisation), which has an Investment Ombudsman: Tel: (020) 7796 3065. 133

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Lump Sum Investment

The regulator for retail financial services is the PIA (Personal Investment Authority):

Tel: (020) 7216 0016. The Securities and Futures (SFA) Complaints Bureau deals with complaints about stockbrokers: Tel: (020) 7964 1482. TAX

Complain first to the officer-in-charge at your local office. If not satisfied, write to the Controller (see leaflet IR20). Finally, there is the Revenue Adjudicator: Haymarket House, 28 Haymarket, London SW1Y 4SP. Tel: (020) 7930 2292.

Glossary Additional voluntary contributions (AVCs). Payments into a company pension scheme in excess of what the scheme requires, to achieve a higher pension. AITC. Association of Investment Trust Companies. All-employee share plan (AESOP). A new tax-efficient employee share option scheme. Annual equivalent rate (AER). Interest rate paid by a borrower which takes account of the timing of payments in order to be fully comparable. Annual percentage rate (APR). Rate of interest received by a lender which takes account of the timing of payments and any associated charges. Annuity. A guaranteed income for life, purchased with a lump sum. Part of the income is interest and part is repayment of capital. APCIMS. Association of Private Client Investment Managers and Stockbrokers. Approved personal pension (APP). A personal pension which can be contracted out of SERPS. AUTIF. Association of Unit Trusts and Investment Funds. Back-to-back plan. Method of avoiding inheritance tax using an annuity. Bank of England Brokerage Service. A service for personal investors to buy, hold and sell gilts as an alternative to the Stock Exchange. Base cost. Cost of an asset for capital gains tax purposes. Base rate. Interest rate fixed by the Bank of England which effectively controls all UK interest rates. Bed and breakfasting. Selling shares one day and buying them back the next, to use any unutilised annual capital gains tax allowance (this is no longer permitted). 135

136

Lump Sum Investment

Bed and ISAing. Same as bed and breakfasting, except that the shares are bought back into an ISA (this can still be done). Bonus issue. Subdivision of existing shares, such as each one into two, thus doubling the number of shares and halving their value. Broker funds. Investments mainly in the funds of life assurance companies where an independent financial adviser or broker makes the allocations to the individual funds. Buy-to-let. Buying a property to rent out in order to get additional income plus the possibility of a capital gain. CATs. Standards for ISAs (and for mortgages from mid 2001). CGT. Capital gains tax. Collectibles. Assets such as antiques which are invested in to make capital gains. Company share option scheme. Share option scheme which can be limited to selected employees and still enjoy tax advantages. Compulsory purchase annuity. The annuity which must be bought from a personal pension scheme on retirement. Contracted out. Not paying National Insurance contributions for or receiving benefits from SERFS (the state earnings-related pension scheme). Contracts for differences. A way of gearing up your trading in shares by putting up only a small percentage of the contract value. Crest. The system of share transactions where the shares are registered in the name of a nominee company. Debentures. Company fixed-interest stocks which are secured on some or all of the assets of the company. Deed of variation. Amendment of a will after death, with the consent of all beneficiaries affected. Earnings per share (EPS). Profit for a period divided by the number of shares in issue. EIS. Enterprise investment scheme. Enterprise management incentives. A new share option scheme for key employees in smaller companies.

Glossary

137

Equities. Ordinary stocks and shares in companies. Exchange-traded funds. A new form of index tracker which is treated as a share rather than a unit trust. Executors. Persons appointed by the deceased to administer the estate. Face value. The issue value of a stock (may be the same as the redemption value). Friendly society. A mutual insurance and savings organisation operating for the benefit of its members. FSA. Financial Services Authority. FSAVC. Free-standing AVC, i.e. an AVC outside a company pension scheme. FTSE 100 index. The index of equity shares in the 100 companies on the London Stock Exchange with the largest market capitalisation. Fund supermarkets. Share ISAs made available by one provider permitting investment in a number of funds, with ease of transfer between the funds. FURBS. Funded unapproved retirement benefit scheme a tax-efficient way of buying to let. Gearing. The ability of an investment trust to borrow money to invest, thus gearing up or increasing the opportunity for growth and/or income increase (and risk of loss). General extension rate. Rate of interest payable on National Savings products which are held beyond their due date. Gift-with-reservation. Gift of an asset where the donor retains some right over it, so that inheritance tax will still be payable. Gilts (or gilt-edged). British government fixed-interest stocks. Gross. Interest paid gross is paid before deduction of tax. Growth. The increase in value of an equity investment. Hedging. Protecting shares against a fall in prices without selling the shares. Hurdle rate. The annual amount by which the asset value of a zero-dividend preference share can fall before redemption value is cut back.

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ICT. Immediately chargeable transfer under inheritance tax. IHT. Inheritance tax. Indexation. Adjustment of value in line with the retail price index (RPI). Index-linked. Varying in accordance with the retail price index, which measures inflation. Individual pension accounts (IPAs). Contractual arrangements similar to IS As and PEPS, for the investment of certain pension contributions. Intestacy rules. Rules for sharing out an estate in the absence of a will. Investment trust. A company whose business is buying, holding and selling shares in other companies. IP A. Individual pension account. IR. Inland Revenue. ISA. Individual savings account. IT. Income tax. Jiway. A new exchange for retail trading in international shares. Letters of administration. Permission to deal with the estate of someone who did not make a will. Loan stock. Unsecured company fixed-interest stock. Loss carry-forward. A net loss in a year, for CGT purposes, which can be taken into the subsequent year(s). LSE. London Stock Exchange. Margin trading. Another name for contracts for difference (CFD). Marginal tax rate. The top rate you pay on your income and therefore the rate you pay on any additional income or save on any income reduction. Market value adjustment. A provision in the terms of managed bonds to reduce amounts on individual withdrawals if there is a considerable fall in the value of the fund, to protect the ongoing investors. National Savings. British government schemes for borrowing money directly from the public. Net asset value (NAV). The market value of the underlying investments of an investment trust.

Glossary

139

Non-quoted securities. UK shares not quoted on the Stock Exchange main market. OEIC. Open-ended investment company, a new form of unit trust, which has only one price for buying and selling, and charges are separate. Offshore investments. Investments abroad, usually in a tax haven. Ordinary shares. Shares in a company which receive dividends out of profits left after paying any interest and preference dividend. Paper trading. Theoretical dealing before actually committing yourself - a good way of trying out the more risky forms of investment. Par value. The nominal value of a share (may be the same as the issue value). PEP. Personal equity plan, no longer available for new investment. PET. Potentially exempt transfer under inheritance tax. PIA. Personal Investment Authority. PIBS. Permanent interest-bearing shares of building societies. Pools. Categories of investments for CGT purposes. Pound-cost averaging. A mathematical advantage from regular investment in equities. Preference share. A company share which receives a fixed dividend out of profit, usually before any dividend on ordinary shares. Probate. Official permission to act on a will. Purchased life annuity (PLA). An annuity purchased voluntarily. Redemption. Repayment, usually of a capital sum at the end of an investment period. Redemption yield. Yield which takes into account the difference between current market price and redemption value, allowing for the time to redemption. Rights issue. Issue by a company of further shares for cash to existing shareholders. Rolling up. When income is kept in an investment instead of being paid out.

140

Lump Sum investment

Save-as-you-earn (SAYE). Contract with a bank or building society to save on a tax-free basis, in connection with a savings-related share option scheme. Savings-related share option scheme. An employee share option scheme associated with a save-as-you-earn contract. Scrip dividend. The opportunity for a shareholder to take new shares instead of a cash dividend. Self-select. A form of ISA or PEP in which you can choose individual investments and change them at any time. Selling short. Selling shares you do not have, in the expectation that the price will fall before you have to deliver. SERFS. The state additional pension, originally called the state earnings-related pension (hence SERPs). SET. Stock exchange electronic trading system for shares in large companies. SFA. Securities and Futures Authority. Split-capital investment trust. The shares are of at least two kinds; usually one kind has the right to all the income and the other to all the capital growth. Spread. The two prices at which a market-maker will sell a share to you (the higher price) or buy from you (the lower price). Sometimes called the margin or touch. Spread betting. Betting on an increase or decrease in the price of shares (or other financial products) by buying or selling the spread - the quoted buying or selling price. Stakeholder pension. New form of pension scheme introduced in April 2001. Stop-loss. A set price for a share held, at a percentage below the highest recent market price, to signal the need to consider selling in order to minimise any loss. Tail swallowing. In a rights issue, selling enough rights to pay the cash required for the balance, thus avoiding the need to put up more cash. Taper relief (CGT). Reduction of CGT on assets held for longer periods. Taper relief (IHT). Reduction of IHT payable in respect of

Glossary

141

ICTs and/or PETs made between four and seven years before death. Taxable. Income paid gross but subject to tax. Taxed. Income which is taxed at source and paid net. Tenants-in-common. Form of property ownership where each party owns part only. TESSA. Tax-exempt special savings account, no longer available for new investment. Testator. Someone who has made a will. Top-slicing relief. Method of calculating higher rate tax when certain period investments are cashed in. Unit trust. A pool of investments managed by a professional company but held in a fund owned separately by a trust. VCT. Venture capital trust. Written into trust. An arrangement to keep the proceeds of a life assurance policy out of the deceased's estate. Yield. The return on an investment (interest or dividend) expressed as a percentage of its market value.

Index all-employee share plans (AESOPs), 69 all-share index, 28 alternative investment market (AIM), 28 annual equivalent rate (AER), 18 annual percentage rate (APR), 18 annual report and accounts, 30 annuities, 95, 99 auditors' report, 31 AVCs (additional voluntary contributions), 94 baby bonds, 102 balance sheet, 31 bank accounts, 35 bears, 21 bed and breakfasting, 120 bed and ISA, 120 blue chips, 27 bonds, 45 bonus issues, 25 borrowing, 13 borrowing facility, 13 broker funds, 59 building society accounts, 31 bulls, 27 buy-to-let, 104 capital gains tax, 114

CFD trading, 66 children's bonus bonds, 31 children's investments, 100 churning, 64 collecting, 107 company fixed interest, 46 company reports, 30 company share option plans, 70 compulsory purchase annuity, 95 corporate bonds, 46 Crest, 28 debentures, 46 deed of variation, 125 defensive stocks, 64 de-mutualisation, 24 deposit accounts, 35 diary, 33 directors' report, 31 dividends, 21 earnings per share, 31 emergency fund, 92 employee share option schemes, 67 endowments, 58 enterprise investment schemes (EIS), 75 enterprise management incentives, 71 equities, 21, 62 142

Index

ethical investments, 103 exchange-traded funds, 53 films, 75 financial health check, 13 financial strategy, 14 fixed-interest investments, 20 fixed-rate savings bonds, 40 friendly society savings schemes, 54 FTSE 100, 28 fund supermarkets, 52 fundamental analysis, 63 funded unapproved retirement benefit scheme (FURBS), 105 gearing, 50 gilts, 42 green investments, 103 ground rents, 106 guaranteed equity bonds, 58 hedging, 64, 67 immediately chargeable transfers (ICTs), 122 income tax, 112 index shares (in shares), 53 index tracking, 53 indexation, 115 inheritance tax, 120 insurance bonds, 54 interim report, 32 international shares, 63 investment bonds, 58 investment clubs, 71 investment income tax, 112 investment trusts, 50

143

IPAs (individual pension accounts), 93 ISAs (individual savings accounts), 84 lifetime gifts, 122 liquidation, 26 Lloyd's names, 77 loan stock, 46 loss carry-forward, 114 managed funds, 56 margin trading, 66 market capitalisation, 27 market-makers, 26 market value adjustment, 57 maximum investment plans, 59 mortgages, 96 National Savings, 37 net asset value, 50 new issues, 24 non-taxpayer, 125 OCO orders, 65 OFEX market, 28 offshore investments, 77 open-ended investment companies (OEICs), 52 ordinary shares, 21 paper trading, 76 par value, 21 pensions, 93 P/E ratio, 27 PEPs (personal equity plans), 89 permanent interest-bearing shares (PIBs), 47

144 Lump Sum Investment

potentially exempt transfers (PETs), 122 pound/cost averaging, 61 preference shares, 46 premium bonds, 41 price record, 32 privatisations, 24 probate, 124 profit and loss account, 31 profit-sharing share option schemes, 70 property, 104 purchased life annuity, 95 receivership, 26 redundancy, 109 reinvestment relief, 117 retirement, 93 rights issues, 24 risk, 23 savings analysis, 15 savings certificates: fixed-interest, 39 index-linked, 39 savings gateway, 47 savings-related share option schemes, 68 SAYE (save-as-you-earn), 68 scrip dividends, 25 selling short, 81 settlement, 28 share option schemes, 67 split-capital investment trust, 78 spread, 26

spread betting, 80 stags, 24 stamp duty, 27 stock exchange, 26 stock exchange electronic system (SETS), 26 stockbrokers, 26 stop-loss, 32 taper relief: CGT, 115 IHT, 121 take-over bids, 26 tax - see capital gains, income, inheritance technical analysis, 63 TESSAs (tax-exempt special savings schemes), 90 top-slicing relief, 55 unit trusts,51 unquoted securities, 122 value investing, 64 venture capital trusts (VCTs), 75 wills, 124 with-profits bonds, 57 written in trust, 125 yield: on gilts, 43 on shares, 27 zeros, 79