RH Investment Services Autumn Edition
RH Investment Services welcomes you to the latest edition of Investment Bulletin, our update on developments in the world's finance sector. We hope you find the contents of interest. If you have any questions, or would like to discuss any of the points raised, please give us a call.
Investing for beginners
Many investors are happy to earn a return from their money simply by sticking it in a savings account. For those who want their money to work harder, the stock market can offer greater potential, although the reward is dependent on the amount of risk you are willing to take. By investing in the stock market, you’re buying shares (or equity) in a company in the hope the company will perform well and the share price will go up. Of course, it can go down as well, which is the extra risk you take on. Stock market investments should be viewed over the medium to long-term and most professionals will advise you to keep them for at least three to five years. If you’re looking to invest directly into a company’s shares, then you should concentrate on companies whose businesses you understand. It helps if you can keep on top of market news and have some knowledge of the way in which the stock market operates. This is difficult for many investors who don’t have the time, experience or capital to invest directly. As an alternative you can invest in equities by putting your money into a collective investment scheme, such as a unit trust or an OEIC (Open Ended Investment Company). Your money will be pooled with that of other investors and the fund manager will select which companies to invest in. You will pay a fee for this service. Some funds aim to provide you with an income, while others are designed to deliver capital growth. Some funds simply track a stock-market index and have no element of stock-picking. Other funds are actively managed and target a particular sector of the stock market, or geographical region. These funds tend to carry higher fees as a result. The advantage of the collective investment route is that with a smaller amount of investment capital, you can achieve a more diversified portfolio. With a professional stock-picker at the helm, you would expect your money to outperform the returns of a savings account. However, to ensure that’s the case, it’s worth doing some research into a number of products to see which one best matches your own financial requirements. There are many products on the market and if you’re looking at investing in equities, you should consider how much risk you’re willing to take and whether you feel confident enough to pick your own stocks – or would prefer a professional to make your choices for you.
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Building a portfolio
Portfolio is the term for a range of investments which is owned by a single person or organisation. It is generally spread across a variety of assets, including shares, bonds, property and cash, the allocation of which has been determined in relation to that investor's objectives. Ultimately, a portfolio’s success is dependent on its performance – but one investor’s idea is never the same as the next. Your attitude to risk is highly personal and the solution you choose must reflect that. Risk is key to helping determine which asset classes you select, and in what proportion. For example, cash is virtually risk free and the interest that it earns provides you with a regular income. However, because there is no risk attached, the income payments are generally quite low and change in line with Bank of England base rates. There is also zero opportunity for capital growth. At the other end of the scale we have equities, ie: shares which allows you to participate in company profits. Equities generally offer greater long term income and capital growth opportunities as a successful company will increase not only dividends but also reinvest in itself, increasing its value. However, unlike cash, equity prices are highly volatile as they react to changes in market sentiment. In addition, if things go wrong for a company, you may end up getting back less than you originally invested. Making this decision, ie: how much of your portfolio goes into each asset class, is known as asset allocation. Combined together, asset classes can actually complement each other, helping to smooth out some of the peaks and troughs of investment performance. Perhaps surprisingly, different asset classes tend to perform in different ways, and this lack of correlation between them means that one will often compensate when another is having a difficult time. A good portfolio should generate the maximum possible return for you for your given level of risk. Of course, you should always remember that investment is for the long term and performance is not guaranteed. Indeed, you may not get back what you invested, particularly if you withdraw after only a couple of years. However, if you have allocated your portfolio in the right way, you are in a much better position to maximise your opportunity and lower your long term risk.
What is a portfolio?
A portfolio is the collective term for the total of all your investments, which might include a range of asset classes, such as equities, bonds, property and/or cash. Its success is dependent on the way it performs, although one investor’s definition of performance may differ from another as we all have a different outlook. Hence, there is no catch-all solution to fit everyone’s investment needs. A good portfolio should generate decent returns while keeping within your risk profile. This is done by selecting an appropriate mixture of different assets, bearing in mind not just risk but also your age, your needs, your timelines and your financial position.
Common mistakes
We are all human and in all walks of life, we make mistakes - which for investors, costs money. Therefore, if you know the most common ones, you can avoid losing out where others have lost before. For example, don't follow the herd – remember when people piled into dotcoms in the late 1990s? Don't sell out on a downturn without serious reason - you are crystallising your loss and may miss out on a rebound. And never chase a quick profit, thinking you can time the market – this is no different to gambling on horses. Investment should be planned and should be for the long term. Any other approach makes it a highly risky business.
Building the core
A core investment is a series of holdings around which you can construct the rest of your portfolio. The theory is you will keep this investment for the longer term, while tailoring other parts of your investment portfolio to follow more shortterm gains or higher risk strategies. Although dependent on your specific attitude to risk, the principle of a core investment is that the majority of your portfolio is invested in mainstream funds which can offer a diversified mix of assets and can provide stable low-risk returns. This can be supplemented by a satellite strategy comprising a smaller percentage of your portfolio, focusing on more specialised areas designed to increase overall returns. For example, you could target a specific industrial sector, such as commodities, or a type of overseas stock such as emerging markets equities. It is important to remember that portfolio risk is a highly personal element which varies from investor to investor and you should be comfortable with the overall level of risk you are taking. Core funds are designed to act as a central focus around which others parts of the portfolio can be planned. Whichever type of core holding you select, it is worth ensuring you remain invested for the longer-term and choose a provider that will be able to keep your investments on track even if your requirements change.
A long term view
Over the long term, the stock market has tended to outperform cash. However, it is also volatile, which has a tendency to scare investors perhaps even tempting them to sell. However, selling after a sharp fall can be a knee jerk reaction. Falls can often be followed by upward movements and, over the long term, shortterm corrections should have no serious impact on your objectives. The nature of share prices means they do go down as well as up, but think before you act. Have your needs changed? Has your attitude to risk changed? Has your overall view of the market changed? If your portfolio is structured to fit your aims, time should be all it needs.
Pensions and ISAs
With longer life expectancies many investors’ are concerned about their retirement income. Some are now looking to boost their pension funds, either by topping up company schemes, or using alternative vehicles. One such vehicle is the Individual Savings Account (ISA) which can also help to ensure your retirement income is as healthy as possible. ISAs and pension plans are both seen as tax efficient investment vehicles. however, there are big differences between the two. For example, when you put money into your pension plan, the contribution qualifies for a tax rebate up to your highest rate which, for a higher rate taxpayer can add a significant amount to their investment. However, in exchange for this benefit, you must keep your money invested until at least age 50, and on retirement, the income you receive is taxable, and counts towards your personal allowances. With an ISA, the money you invest comes from taxed income and no rebate will be given. However, ISAs have no minimum term - so you can withdraw the proceeds, or an income before you reach 50. In addition, any income you do withdraw will be tax free and will not count towards any personal allowances. Which approach is best for you depends entirely on your personal situation. Call us if you would like to find out more.
What is a PEP?
PEPs were the predecesors to ISAs. Introduced in 1987, PEPs (Personal Equity Plans) were taxefficient vehicles and there were two main types: the single company PEP; and the general PEP allowing a selection of investments. Although you cannot take out a new PEP, any you have can continue to exist with similar levels of tax-efficiency to ISAs - and the ruling dividing the two types of PEP has been abolished. If you own any PEPs it’s certainly worth ensuring they work as hard as possible and, using the robust PEP transfer market, you can search investment managers to provide competitive performance in the same way as ISA investors.
Issued by RH investment Services which is authorised and regulated by the Financial Services Authority. The contents of this newsletter do not constitute advice and should not be taken as a recommendation to purchase or invest in any of the products mentioned. Before taking any decisions, we suggest you seek advice from a professional financial adviser. All figures and data contained within this document were correct at time of writing.
What is an ISA?
An Individual Savings Account (ISA) is basically a tax efficient wrapper which you can place around a wide array of assets or investment funds to protect them from Capital Gains Tax on growth and any additional liability to Income Tax on income. There are two types – the mini and the maxi – and in this tax year (2007/08), you can invest a total of up to £7,000. A maxi ISA allows you to invest all £7,000 into stocks and shares – either directly or via collective investments. Using mini ISAs, however, you can split your £7,000 across assets, with up to £3,000 going into deposit based savings accounts and up to £4,000 being available for investment in stocks and shares.