How to invest a lump sum?
|Retirement | Investment Choice
Asked by thegambler, submitted
11 September 2011.
I have £80,000 to invest, as I don't need income just capital growth, can you suggest the best tax efficient way to invest this sum. Given I pay tax at 40%, my wife pays tax at 20%, and I have a mortgage with 10 years to run.
Answered by Justin on 27 April 2012
As you and your wife are both taxpayers, using individual savings accounts (ISAs) would be a tax efficient way to hold both cash and investments such as corporate bonds and shares You can currently invest up to £11,280 per tax year (running from 6 April to following 5 April), with up to half allowed to be held in cash. Pension contributions are also tax efficient, although the money will be locked away until retiement (age 55 at the earliest).
Outside of an ISA/pension savings and income producing investments would be more tax efficient held in your wife's name, as she's in a lower tax band than you, although you should obviously check whether the extra income would push her into the higher rate tax band. Growth investments would be more tax efficient held jointly (or split between the two of you) so as to benefit from both of your annual capital gains tax allowances of £10,600 each (gains realised up to the allowance from selling investments are not taxable).
Although you're seeking growth and not income, cash along with some investments (such as corporate bonds, commercial property and dividend paying shares) generate an income, even if you decide to reinvest this for growth, so it's important to understand the tax implications of the various options available to optimise how you hold them.
The big question is what investments should you buy with the money - this is far harder to answer! It really depends on how much risk you're comfortable taking.
The safest option is to stick to cash, as it can't fall in value (if we ignore inflation and assume the bank doesn't go bust - you'd be covered by the FSCS up to £85,000 per institution per person in the event of the latter). 'Best buy' rates are (at the time of writing) around 3% for easy access accounts rising to around 4.5% fixed for 5 years (see Moneyfacts http://moneyfacts.co.uk/compare/savings/accounts/best-sellers-savings/?hp for a comprehensive list).
The alternative to cash would, of course, be to pay down/off your mortgage. if your mortgage rate exceeds what you could earn on cash (after tax) it seems a no-brainer, although you would of course lose the flexibility of having the cash at hand for other purposes should you need/want it. An offset mortgage overcomes this by effectively offsetting your savings against your mortgage balance, reducing your monthly payments (which is basically the same thing as earning tax-free interest).
I can't see interest rates rising for at least a couple of years, as our economy remains troubled and raising rates would further hamper recovery, as well as killing the struggling housing market.
The trouble with cash is that at current interest rates it won't make you rich. But seeking higher returns means taking risk, i.e. being comfortable you could lose money, especially shorter term. And current global economic uncertainly has created very nervous (volatile) markets, exacerbating the risk.
Investment areas you might consider include:
Stock markets - all over the place at present and I can't summon must enthusiasm for the outlook over the next year, especially if the eurozone plunges further into crisis which looks likely. However, I think emerging markets are still a good 10+ year bet and higher dividend shares might turn out ok shorter term if markets don't fall back too far.
Corporate bonds - at the safer end of the scale high demand means yields (i.e. income) are little better than cash, although if stock markets dive again this would likely push up demand hence prices. Higher risk bonds have reasonable yields but are more susceptible to economic and stock market downturns - as this increases the perceived risk that your loan won't be repaid (bonds are basically IOUs, where you lend money to governments and companies).
Commercial property - The market has picked up since a disastrous patch during 2007/08, but is hardly firing on all cylinders. The UK IPD All Property Index shows a total return of 6.6% over the last year, with most of this coming from rental income. If the economy holds firm then rents should remain stable, but it's still a delicate marketplace.
Commodities - gold has benefited from nervous markets while other metals have benefitted in recent years from huge emerging markets demand (especially from China) to build infrastructure. Soft commodities (e.g. food) have also generally benefitted from erratic weather and growing populations, but prices remain very volatile. I think commodities is a sensible place to be over 10-20 years (thanks to continued emerging markets growth), but the potential risks are high short term, as prices certainly don't look cheap.
Absolute return - these fund investments aim to make positive cash-beating returns whether markets rise or fall. Trouble is, many have failed to do so as it still relies on human judgement which is prone to error.
There's also the decision on how to access investments, i.e. buy directly or through investment funds (and the latter might be run by active managers or simply track an index). In general, unless you're prepared to be hands on then funds are a convenient route, albeit usually more expensive - especially if actively managed.
I can't really tell you which of the above, if any, would be right for you, but hopefully my comments might help you get a better feel for what could be suitable for you. Of course, my outlook for the above investment types may be proved wrong, but hopefully an appreciation of the relative risks involved will help you make a sensible decision.