This article follows - Planning for total financial health (the importance of a financial coach)
Let’s imagine you’re up to speed with the general idea of building your wealth and appreciate the importance of financial security and independence as a component of your overall well-being. Since the onset of the pandemic and global downturn, you’ve been able to continue working (‘earning it’), your outgoings have reduced and you have built up healthy savings (‘keeping it’), and you are now looking at what to do next (with a view to ‘growing it’).
Alternatively, perhaps you’re sitting on a lump sum following some other event, that may or may not be related to Covid: retirement, redundancy, inheritance, success with those shares you dabbled in. Do you have a pot with no name? Maybe you’re just curious about how investing works or are wondering how you can benefit from this unfolding Covid story. Change brings opportunity but, inevitably, there will be both winners and losers - there is always risk - so you should place your money only in a way that is acceptable and appropriate to you.
Adapting the life plan
With the banks and National Savings unable to offer even inflation-beating returns, we are forced to look elsewhere if we are to see our wealth grow. You should be spending only what you need, keeping (or building) an emergency fund, and investing the rest. Otherwise, your wealth could be eroded over time, perhaps before you even notice. There are different ways to invest and, clearly, the right solution for you will depend on your goals, circumstances, mortgage status and attitudes. If you don’t already have a life plan (and many people don’t), this is one occasion where an advisor can help get you focused and motivated to act. Turning your dreams into realistic, achievable goals, if you like. The UK is a nation of procrastinators and, this year, families have been denied the usual opportunities for festive family conferencing.
Finance - the 'fourth pillar of health'
What follows, then, is a summary of The Rules of investing as well as a look ahead to what the rest of 2021 may hold in store for us.
What is investing? What is an investment?
Investing is not the same as saving or trading.
Generally investing is associated with putting money away for a long period of time in the expectation of a return for the investor. Leaving investments untouched for long periods (five years or more) means they are exposed to the magic of compound interest. There are different asset classes but the term investment is normally associated with stocks & shares - small parts (units) of big companies, the prices of which fluctuate according to supply and demand. Investing is riskier than saving money. Savings are sometimes guaranteed but investments are not. Good investments will increase the net worth of an individual over time; bad investments leave you worse off. There are costs to investing. There will be good years and bad and, yes, you might get back less than you put in. But following The Rules will greatly improve your chances.
Growing wealth is a bit like growing trees in that the best time to get the ball rolling was probably 20 years ago. But the second-best time is now. Just like in other areas of our lives, it is never too late to start working towards your potential and a good coach will get you mobilised faster.
Why start early?
By definition, investments demand that you take a long-term view. Investing requires patience, especially in the early days when, like the drawing out of our winter evenings, progress may be imperceptible to begin with (or even negative, depending on the ‘weather’). This approach also negates the need to try and time the markets – a typical rookie ploy. ‘Time in’ is invariably more important than ‘timing’.
By way of illustrating how these first two rules can play out in your favour, here are a couple of examples…
Did you know?
Investing £1 a day for the first 18 years of a child’s life should generate a pot of £11,000 by the time the child reaches the age of 18 (assuming a medium risk approach, well-diversified portfolio and average investor returns). At this point, you can stop contributing and, provided it remains untouched, the pot should continue to grow to £25,000 by the time the child is 34. The magic of compound interest has turned a capital outlay of £6,480 into a meaningful deposit for a first house (coincidentally, 34 is the average age that ‘youngsters’ buy their first property these days). This is worth considering as that first rung on the ‘property ladder’ creeps ever skywards.
Did you also know?
It is possible to start a pension from birth and HMRC permits contributions of up to £3,600 per annum. Even though babies can’t work, and therefore do not pay tax, their pension contributions enjoy an immediate 25% uplift in the form of basic rate tax relief. Paying in the maximum of £240 per month therefore leads to a pension pot (again, assuming a medium risk approach, well-diversified portfolio and average investor returns) of £103,579 by the time the child reaches the age of 18. Switching off contributions at this point - and leaving the investment until the ‘child’ reaches 65 - means that the power of compound interest should grow the pension pot to just over a million quid! If managed sensibly, this should provide a retirement income of up to £50,000 each year, without eroding the capital sum, and therefore also leave a sizeable legacy.
These 2 examples have been chosen for several reasons. Firstly, juniors have a long investment window ahead of them and, with the right guidance, can start building very early. Children also make incredibly good investors! This is because they tend not to know or care too much about money, where it comes from or why we need to look after it. So they do not tinker with things and instead let compounding run its course. This innocence is endearing but the world will ultimately be an unhappy place for children unless they are taught to ‘earn it, keep it, grow it’. Also, our spending habits are shaped by the time we reach the age of 7 so, parents, this education piece is likely down to you!
You might be thinking at this stage – how many parents can afford to put away this kind of money for their offspring? Admittedly, relatively few and normally only those either on good money and/or coming into parenthood later in life. But in the case of Junior ISAs and pensions, well structured plans allow contributions from third parties (such as relatives and grandparents) who might also welcome the opportunity to make gifts as part of an estate-planning strategy. A good financial planner will take a holistic approach when working with families and look for any intergenerational opportunities like this. Again, taking action in a timely fashion can pay dividends in the long run so, please, start early and be prepared to play the long game - among the saddest words an advisor can be told are, “I wish I’d met you 10 years ago!”
Extra exposure could mean extra pain should there be a correction in the property market
The next important thing to do is make certain that you diversify your investments. This is not a natural tendency for us Brits and I say this because the first thing we seem to want to do when a bit of cash comes our way is buy a (second) property. It’s part of our culture to own property (‘An Englishman’s home… ‘) and, without doubt, this asset class has served us well over the years – after all, we live on a congested island with a growing demand for housing, so simple geography and demographics tell us that prices should continue to rise in the long term. But those prices are at historic (if not all time) highs and, for anyone already paying a mortgage, buying additional property means duplicating what is already in the ‘portfolio’. Extra exposure could mean extra pain should there be a correction in the property market, something that few are ruling out when the stamp duty holiday closes in March.
In any case, HMRC (‘The Taxman’) knows about our love for ‘bricks and mortar’ and has structured the tax regime accordingly – relief on interest repayments has been rescinded and a heightened capital gains tax (CGT) could apply when second properties are sold, gifted or split (this persistently seems to catch landlords out!).
I digress. Diversification is your friend and particularly when conditions are volatile (‘bouncy’, as they are now). Over the long term, most stocks & shares will grow – at different times and at different rates. Some will fail. This is why it pays to hold assets that complement each other and probably a range of vehicles (or wrappers) too. Have you had a bit of joy in the markets this year? Was it down to luck? Perhaps you bought some shares after the downturn and have since seen them shoot back up. Maybe you are sitting smugly on some crypto. It could be that you have been swept along by Tesla-mania. Getting a good return in the second half of 2020 does not make you an investor – for the simple reason that you probably haven’t followed all of The Rules – and in fact your ‘success’ (luck) might place you in a precarious position because you don’t really understand why you were ‘successful’ and are unsure about what to do next.
Apolitical, amoral and agenda-free markets
In fact, do you really understand where you are invested and what you are invested in? Most ‘DIY’ investors do not, and are also oblivious to how their behaviour could be reducing their returns. Whilst the markets themselves are apolitical, amoral and agenda-free, they are driven by sentiment and two very simple human emotions in particular: greed and fear (fear of losing all your money, fear of missing out).
If you are not in control of your behaviour (and, guess what, you’re human so most of the time you are not), you are likely to be susceptible to the many biases that can plague the decision-making of even the most experienced investors and institutions. Be aware of your emotions. Or check in with your adviser before you pull the trigger on anything – because often the best course of action is to just ‘do nothing’ (find your inner child!) and certainly not be steered by the behaviour of others (you should be running your own race).
Can we forecast financial health for 2021?
The New Year has dawned, with perhaps more hope than normal and, maybe, more opportunity too. We can carry on moaning about 2020 or we can learn from it and move forward, stronger. Ultimately, we cannot influence the future any more than we can predict it. So a final rule might be to focus only on the things you can control. Anything else is really just noise and, trust me, there will always be noise – we’ll get through Covid and something else will come along to try to distract you from sticking to The Rules! Don’t ignore the noise completely. But do stick to The Rules as best you can. A good adviser will help you to form a life plan and stay on track.
Paying for 2020
2020 has left us creaking. The eye-watering amounts borrowed will have to be paid back somehow and somewhen. In spite of the relative power of the current UK majority government, it is unlikely that there will be swingeing measures implemented in the next budget as this would make little sense while the country labours on under Covid. Yet changes are inevitable; there will be cuts; taxation will be ramped up; reliefs will be withdrawn. A one-off wealth tax? Possibly. Replacement of higher and additional rate tax reliefs for pension contributions (with a more blanket approach)? Perhaps. Increases to Capital Gains Tax (so that it aligns with income tax)? Almost definitely. A simplification of the highly emotive Inheritance Tax regime? At some point, yes. Can you control any of these things? No. So don’t worry about them (remember?!). Instead, you should look to make the most of the reliefs and allowances that are available to you now. Prioritise your pension and you won’t go far wrong. Why? Because the tax-efficiency of this wrapper can’t be beaten. For now. Maxed out your pension? Well done you! Ask your adviser about alternatives that could be suitable for you.
What other changes has the pandemic catalysed?
The pandemic has catalysed other changes. Some are complete, others are still underway:
- The ‘mass exodus’ from London has been good news for the periphery (where I live in Kent, conveyancing instructions and rental interest have both doubled in places, compared to previous years). What does this mean for Londoners? Stock of larger dwellings could be discounted but flats and weekday-living accommodation should hold up.
- Large US technology companies (collectively known as FATMAAN) have thrived during Lockdown but some of these offer only extrinsic value for investors. If Biden breaks them up, or the bubbles burst, this will bring their market caps down. Growth investing appears to be giving way to a Value approach.
- The FTSE comprises, typically, more traditional stocks - there is no ‘Big Tech’ in the UK to prop up this index and Brexit has also weighed heavily on UK markets. The handbrake is now easing and, fundamentally, UK companies offer a compelling argument for the medium term.
- The ‘green shift’ is underway and investing can, finally, be a force for good in this finite World. A shift to sustainable funds within your pension can be 27 times more effective at reducing your carbon footprint than all of your other eco-friendly efforts combined.
With investors, pension savers and Wealth Management companies all becoming more discerning when it comes to the ESG (Environmental, Social and Governance) credentials of the funds and companies they are investing in, the returns are also there and now is the time to buy into this movement – you won’t be the only winner.