In Focus - Summer 2022
Welcome to the latest issue of In Focus, your quarterly financial planning newsletter.
<big>In Focus
<b>Your quarterly financial planning newsletter <br>Summer 2022</b>
<i>In this issue: </i>
• How to invest in uncertain times
• How could higher interest rates and inflation affect you?
• Five smart ways to help cut your tax bill
• Pension vs. property for funding retirement
<big>Welcome
<strong>Welcome to the Summer 2022 edition of In Focus.
Find out what's in this issue:
Welcome
Welcome to the latest issue of In Focus, your quarterly financial planning newsletter.
In this edition of In Focus, we offer four new articles to inform and inspire your thinking.
We hope you find this content helpful and invite any questions you may have on these topics, or regarding your own financial planning.
How to invest in uncertain times
How to invest in uncertain times
A recent Telegraph article looked at the case of Douglas*, who held £345,000 in cash, and wanted to know if - and how - to invest it. The article suggested there were at least two main concerns about what to do.
First of all, inflation is sitting at nearly 9.1% in May 2022 meaning that real returns from cash (i.e. those after inflation and tax) are impossible, due to low interest rates.
Secondly, however, is now a good time to invest a cash pile in the stock market given its recent volatility? The S&P 500 - formerly at an all-time high in December 2021 - has been moving in a downward trajectory since the new year started.
In the UK, the FTSE 100 is up from 12 months ago, yet there has been volatility along the way.
All of this raises important questions - how should Douglas, or you, invest when markets are uncertain? Is it best to wait until conditions improve before committing a lump sum? Should you, instead, invest your money gradually (“pound cost averaging”)?
Establish your risk tolerance
Many people view investing as risky, yet it is important to recognise that, in 2022, cash is no haven of safety. In fact, holding too much is a near-certain loss. If, for instance, you have £300,000 in a regular savings account at 1% interest, but inflation is 9%, then if this holds for a 12-month period you will make an 8% “real” loss (despite your bank statement showing that you have earned more interest). Financial planners therefore recommend you keep a cushion of cash in easy-access vehicles to allow you more flexibility.
Over and above this cushion, investing the rest is a good idea to grow and/or preserve your wealth over the long term. But it’s wise to establish your risk tolerance (or “appetite”) early on. This makes it less likely that you will make impulsive decisions when markets are volatile, such as selling shares in a bear market (which crystallises your losses). Jumping in and out of the market - trying to time it - is one of the worst things you can do as an investor. So, establish a strategy early on that you are happy with, and can refer back to when markets become unstable.
Marry your goals and investment horizon
What do you want to achieve with your investment portfolio, and how long is it until you will need the money? Having a clear vision is helpful to staying the course in turbulent markets. If you plan on accessing your funds within 1-5 years (perhaps to put down a deposit on a property), then your investment “horizon” is relatively short. This encourages a more “cautious” investment strategy, where maybe more of your portfolio comprises A-listed bonds and dividend-paying equity funds with a history of low price volatility. This helps protect your investments if there is a stock market fall during your investment window (but as always, there is no guarantee and investments can still go down as well as up).
If, however, you are investing to build up a retirement fund and you are still early in your career, then you can take more risks (to access higher potential returns). The stock market, in particular, is quite volatile in the short term and may even experience periodic falls. Yet, over the long term, equities have historically risen. To take the S&P 500 as an example, this has fallen by 6.21% over the last 12 months. Yet between 1957 to 2021, it has averaged 10.5% per year.
Even with longer investment horizons, however, you still need to take steps to mitigate needless risks. Diversifying your portfolio across multiple markets, companies and asset types is one way to achieve this - spreading your investments out so they are not overly-exposed to any risks that are associated with any particular one.
Gradual vs. lump sum investing
Some people will be investing on a regular basis - putting some of their monthly salary towards pension funds, for instance. However, what should you do if you come across a lump sum of cash to invest (e.g. from a sudden inheritance windfall)? This can be particularly challenging during uncertain markets. Many people are reluctant to invest a large amount of money at once. After all, what if you do so and the markets drop further, soon afterwards?
In such a situation, a delicate balance needs to be struck. On the one hand, holding too much cash for too long means it will suffer a “real loss” in a high-inflation environment (as we are now, in 2022). However, you do not want to be reckless with your money. Here, it can be helpful for some people to gradually “drip feed” the money, into a portfolio over time (e.g. 12-24 months).
This “pound cost averaging” approach may not be as efficient as investing a lump sum over the long term, but it can lower the average price you pay for shares during a volatile market. If you have a lower risk tolerance, this can help you stay invested when your emotions are pulling at you.
Work with a trusted adviser
Using a Chartered financial planning firm can be hugely helpful if you’re looking to build - and improve - a strong portfolio that helps carry you through volatile markets. Not only can they identify opportunities and risks in your strategy that you may have missed, but your planner also acts as an important “sounding board” for your investment questions and worries.
Getting an authoritative opinion could make all the difference to helping you stay the course.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest.
How could higher interest rates and inflation affect you?
How could higher interest rates and inflation affect you?
Inflation for May 2022 has now hit a 40-year high, standing at 9.1%. Given that the Bank of England’s (BoE) target is 2%, this represents a big challenge for the UK economy. Trying to counter rising living costs, the BoE has raised the UK base rate four times in six months.
At present, the base rate stands at 1.25%; the highest since the 2008-9 Financial Crisis.
Uncertain times lie ahead, and households are looking for clarity about how all this affects them - and what they should do. Building on our update on inflation and interest rates from last spring, we wanted to offer our latest thoughts on the subject to help you navigate this difficult economic environment in 2022.
What is inflation and the base rate?
To recap, inflation refers to the overall rise in costs in an economy over time. Here in the UK, a common measure is the CPI - Consumer Price Index - which takes a “basket” of 700 goods and services and measures the average price increase, using information from over 120,000 various retailing outlets. The BoE recognises that a gradual inflation rise is good, signalling that the UK economy is growing. However, if prices rise too quickly then it can cause problems.
Higher prices can lead to higher “input costs” for businesses (i.e. buying items from suppliers to make their own products). This eats into their profits unless these costs are passed down to customers, yet doing so may lead to fewer sales. This can be a big problem for industries which have very thin margins, - leading businesses to fail and resulting in rising unemployment.
High inflation is also typically bad for savers, since interest rates from savings accounts can’t keep up. This leads to an increasing “real loss” in the value of cash savings, since £1 can’t stretch as far as it did a year ago.
The BoE can try to “dampen” inflation by raising interest rates. This increases the cost for the UK government to borrow money and (usually) leads banks to raise their own interest rates for customers. This in turn encourages people to save more, if they can get a better return on their regular savings account. Since there is now less spending in the economy, downward pressure falls on the rate of inflation. However, a higher BoE base rate also tends to mean banks raise mortgage rates - leading to greater borrowing costs for homeowners. So, whilst your cash savings may earn more in a high-interest rate environment, in real terms you may be no better off if your mortgage goes up. In fact, you may be worse off.
What’s going on with inflation & interest rates in 2022?
Both inflation and the base rate in the UK now stand at their highest levels in years. Worryingly, the BoE has stated that much of the former is outside their control. Governor Andrew Bailey has warned of an “apocalyptic” inflation rise in 2022, with projections that it could exceed 10% by the autumn. In the 6 weeks preceding the end of April, world wheat prices rose 25% - driven heavily by the conflict in Ukraine, which is a major global supplier. The Russian navy is blockading Ukrainian ships from exporting - leaving huge stores of food stuck in warehouses.
The War has also driven up the cost of energy due to sanctions on Russia, which is the world’s third largest oil producer. Whilst the UK imports relatively little of its energy from Russia (8% of oil and 4% for gas), the situation has driven up global prices - which are then passed on to the UK. This is partly the reason why Ofgem - the UK’s energy regulator - raised the energy cap by 54% (£693) in April 2022. Indeed, costs could rise even further in the autumn, possibly by 20% or even more. It is a grim situation which will put a lot of pressure on many households (in response, the Chancellor announced earlier in the year that a range of rebates would be made available to help offset some of these increased costs).
Will the BoE raise interest rates further if 80% of inflation is out of its control (as the Governor has stated)? This is difficult to answer. The Bank has already raised the base rate four times since December 2021: from 0.1% (an historic low) to 0.25%; to 0.5% in February 2022; 0.75% in April and, most recently, 1.25%. However, the BoE will be wary of raising rates too high. Doing so is likely to halt price growth in the property market, or even reverse it. Moreover, it could cause a sell-off in the equity markets as more “cautious” investors seek the better interest on offer from “safer” government bonds.
Financial planning implications
We understand this is not the most encouraging reading. Yet, as a Chartered financial planning firm, we want clients to see clearly ahead with their eyes open. This will help you prepare your finances and maintain some stability. In light of the above, we suggest checking your emergency fund. Try aiming for a few months’ living costs – your adviser can help you work out how much you need.
Also, consider your mortgage carefully if you own your home. Borrowing too much could create problems later if interest rates continue to rise. For some, it may be worth waiting a bit longer to build up a bigger deposit (to ensure that your budget can cope comfortably with a possible rise in rates). Savers should also think about the cash they are holding. Whilst an emergency fund is wise, your wealth will be disproportionately eroded - in real terms - by inflation if you hold too much in cash (since interest rates cannot keep up with high inflation). As such, you may wish to speak with a financial adviser about other assets and investments which offer a better return*.
*As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest.
Five smart ways to help cut your tax bill
Five smart ways to help cut your tax bill
With living costs rising across the UK in 2022, many households are understandably looking to save money on their monthly expenses. Cutting back on discretionary spending can be a good strategy, yet many people overlook their tax plan. Saving on needless taxes could be equally - perhaps more - effective to ease strain on your budget. Below, our team at Punter Southall Aspire outlines five ideas to help lower your tax bill and reduce the impact of inflation on your finances.
#1 Double-check your tax code
Every year, millions of people pay more in tax due to being on the wrong tax code. This is the code used by the government to determine your National Insurance (NI) and income tax liability on the PAYE (pay as you earn) system. If you have one job or pension, most people will be on the 1257L code. Yet Be aware that HMRC has said that it is your responsibility to check you are on the right code - they will not do it for you.
You might end up on the wrong code, for instance, by getting placed on “emergency tax” after changing jobs. This taxes all of your income above the basic Personal Allowance and is meant to be temporary. However, things can go wrong (e.g. if your employer fails to notify HMRC). You can check your tax code easily on your P45 or by contacting your HR department.
If you have been overtaxed, then you can contact HMRC to claim a rebate (which could be worth £100s, perhaps a lot more).
#2 Reduce child benefit charges on higher income
For those with a child, a child benefit charge is levied if one - or both you and your partner - have an adjusted net income over £50,000. If you are married, live together or are in a civil partnership then the person with the highest net income pays the charge. This is levied at 1% for each £100 of adjusted net income over £50,000; with the amount effectively brought to £0 once your income hits £60,000.
Child benefit can really help families (especially larger ones) manage their budget, letting them claim £21.80 a week for their first child and £14.45 a week for any children after that (up to 20 years old, if they are still in education/training). For a family with five children, for instance, this could be worth £4,138.2 per year.
As such, reducing your adjusted net income - by making charitable donations or contributions towards your pension - could see your child benefit charge lowered, or even eradicated , so that you could keep more of the original benefit.
#3 Optimise your employment status
Are you employed, self-employed or both? Do you own a limited company? Your employment status can make a big difference to your tax bill (depending on your circumstances). Suppose you own two Buy To Let (BTL) properties and earn a salary of £70,000 through your job. This puts £20,000 into the Higher Rate income tax bracket (40%) - setting aside any rental income you receive from your BTLs. However, one idea to potentially save tax is to place these into a limited company structure.
Doing so would make your rental income subject to corporation tax - much lower in 2022-23 at 19% than the 40% Higher Rate. Also, certain expenses on your BTLs can now be deducted - saving you even more. However, you do need to bear the disadvantages in mind when making this move. In particular, selling your BTLs would mean that profits are no longer free of capital gains tax (CGT) up to £12,300 in a given tax year, for example. There are also other costs with running a limited company - such as legal fees and annual auditing - which can erode income.
#4 Make your investments tax-efficient
Each tax year, you are entitled to a range of tax allowances. Many people do n’ot use them to their full advantage, which is money gone to waste. Each year, for instance, up to £20,000 can be put into your ISA(s) and any interest, capital gains and dividends generated inside will be free from tax. As one example, if you have a larger amount of cash in a general investment account (GIA), it may not be the best way to produce your returns - since much of your income and profits will be liable to capital gains tax (CGT) and/or dividend tax.
Moving your investments gradually into an ISA could be a good way to make this portfolio more tax-efficient. However, bear in mind that you are also entitled to a £12,300 CGT-free allowance each tax year, as well as £2,000 in dividends without tax. This helps you to save on tax in the shorter term whilst you make the transition.
#5 Claim your full relief entitlement
This may not help your finances early in your career, but claiming your full tax relief on pension contributions will help boost your retirement fund - potentially giving you a better lifestyle when you finish your career. Employed Basic Rate taxpayers get 20% relief on their contributions by default under the PAYE system (via auto enrolment). However, those on the Higher Rate and Additional Rate will need to claim the extra relief (20% and 25% respectively) using their Self Assessment Tax Return, via a letter to HMRC. Also, if your employer offers to match your own contributions (normally up to a limit), then make sure you take full advantage of this - since it effectively doubles your contributions!
Pension vs. property for funding retirement
Pension vs. property for funding retirement
The British are renowned for their love of property. 85% of private tenants wish to own their own homes within the next 10 years, whilst 65% of Britons have bought the property they live in (in Germany, the figure is 43%).
The British love of property even leads many to ask whether it can be a viable source of retirement income. After all, if you can buy, say, three properties and settle the mortgages, you could then rent them out and live off the income. Yet how does this strategy compare to using pensions - the other popular way to fund retirement?
Property & retirement: an overview
Investors are often attracted to property because it is a “tangible” asset - you can see, touch and feel it, unlike stocks and bonds (which seem “immaterial”). Moreover, UK property has enjoyed a lot of growth over the years - despite slumps along the way. In 1980, the average UK house was £19,273; today, however, it stands at £274,000. Compared to even the stock market, this is an astonishing rate of capital growth.
Little wonder, therefore, that many are drawn to Buy to Let (BTL) as a potential way to fund their retirement. The common idea is to buy a property and use the rental income from your tenants to cover your costs. Whilst (hopefully) making a small profit along the way, when the mortgage is eventually paid off, you can enjoy the majority of the income for yourself. Given enough income, this could pay for a retirement lifestyle.
Issues to consider
All of this makes buy-to-let a compelling picture for many people. However, the big risk is that you have long periods of tenant absences. During the COVID-19 lockdown from March 2020, for instance, many BTL landlords struggled to gain tenants due to stringent quarantine and social distancing measures. Even many of those with tenants struggled to collect rent as people lost their jobs, but could not be removed from the property due to the Eviction Ban. In such a situation, landlords are forced to cover their BTL mortgages themselves.
For many in 2020, this was impossible. However, selling a BTL portfolio was also tremendously difficult since the housing market had come to a standstill. This highlights another risk with BTL; that direct property investments are more “illiquid” than many “intangible” investments, such as stocks and bonds. There is also no guarantee that you will make a capital gain on your property sale. If you take out a BTL mortgage and the property value drops below the loan value, then you could end up in negative equity if you need to sell.
These scenarios are difficult for those still working in their careers. However, for someone who relies on BTL in retirement - with little/no other income streams - they could be devastating.
Pensions & retirement
Comparing property to pensions is difficult. First of all, the latter is a financial “product” whilst property is not only an asset - but it is also, often, a home. Secondly, there are various pension types which can muddy the picture:
- State Pension. This is an income from the government. It is provided weekly for the rest of your life and is based on your National Insurance (NI) record.
- Defined benefit pension. Sometimes called a “final salary” pension, this involves your employer promising to pay you a guaranteed lifetime income in retirement.
- Pension pots. Technically called “defined contribution” pensions, you can build up a pension pot on your own (e.g. using a personal pension) or with your employer via a workplace pension, under auto-enrolment.
The first two types offer a significant advantage over property for retirement income. Whilst a property may depreciate or fail to provide rental income for certain periods, your State Pension (and a final salary pension, if you have one) will always provide an income until you die. This is enormously reassuring and provides stability.
A pension pot also has its own benefits. In particular, the UK government will “top up” anything you put into your pension pot(s) according to your highest rate of income tax. Your contributions are capped at £40,000 per year or 100% of your earnings (whichever is lower). So, for a Basic Rate taxpayer it only “costs” 80p to put £1 into their pension (20% relief), whilst for someone on the Higher Rate the cost is 60p. Over years of contributions, this adds up to huge, tax-efficient extra growth for your retirement fund when combined with the power of compound interest.
The main drawback from pensions is that your money will be largely invested. The stock market goes up and down, and there is a risk that your pension(s) may not last in retirement unless you plan carefully.
Suggestions for retirement planning
Ultimately your financial goals, current situation, investment interests and risk profile will play key roles in determining the role of pensions and/or property in your retirement plan.
For some, combining the two can be appropriate. Perhaps you could hold a second property providing a rental income, for instance, whilst also enjoying income from your State Pension and one - or more - pension pots.
One thing to bear in mind is diversification risk. With a second property, most people will need to allocate a large part of their wealth towards its purchase. If your plans do not work out, then this can lead to disproportionate loss compared to someone with a more “spread out” portfolio (i.e. across cash, shares, bonds and property funds).
