LG Investment News

Welcome to our latest issue of Lyon Griffiths’ Investment News.

We aim to communicate the key current topics in the world of financial advice and highlight the up and coming issues in an understandable and digestible format.

In this Edition:

  • Income tax
  • Marriage allowance
  • Venture capital
  • State pension
  • Inflation gets complicated
  • Interest rates are set to rise
  • Deferring retirement
  • Market timing
  • Dormant pensions grab

 


Income tax


With effect from April 2018, basic rate tax will become payable when income exceeds £11,850 per annum (an increase of £350) and higher rate tax (at 40%) will apply to income in excess of £46,350 per annum (an increase of £1,650). Additional rate tax will continue to be payable at 45% on income over £150,000 and tax on dividends at 38.1%.


Marriage allowance


Spouses are permitted to transfer 10% of their personal allowance to each other, provided neither are higher or additional rate taxpayers This can be backdated for up to four years and legislation is to be introduced to allow transfers to be made from or to a deceased spouse within the same four-year period.


Venture capital


The rules are to be tightened-up to restrict investments which qualify for the tax advantages enjoyed by Venture Capital Trusts (‘VCTs’), Enterprise Investment Schemes (’EISs’) and Seed EISs (‘SEISs’). In future, investments must be confined to entrepreneurial companies whose objective is to grow and develop and which involve a significant risk of capital loss.

Additional encouragement is to be given to investing in “knowledge intensive” companies, which satisfy various conditions such as engaging in the creation of patents and other intellectual property and having a certain number of skilled employees. The annual limit for investment in an EIS will be increased from £1 million to £2 million where more than £1 million is invested in such companies.


State pension


The basic State pension will be increased by 3% (£3.65 per week) and the new State pension by £4.80 per week in accordance with the “Triple lock”. This is the government commitment to increasing payments every year by whichever is the highest of inflation, average earnings and a minimum of 2.5%.


Inflation gets complicated


After an extended period of exceptionally low inflation and low interest rates, Inflation is on the rise and interest rates seem set to rise, albeit slowly, in response on both sides of the Atlantic. But inflation affects different people in different ways, and there are several alternative ways in which inflation is measured.

The Retail Prices Index (‘RPI’) was created in 1947 when the typical shopping basket consisted of items we barely recognise today: rabbit meat, cod liver oil, tinned salmon, lamp oil, condensed milk and hats.  Reflecting the very different lifestyles of today, these items are no longer included among the 700 items by which the prices are now measured by the Office for National Statistics to calculate RPI, the latest additions to which include gin and non-dairy ‘milk’ drinks.

A second inflation index, the Consumer Prices Index (‘CPI’) was introduced in 2003 and comprised a different basket of consumables from the RPI and excluded mortgage interest payments. CPI is on average 1.2% lower than RPI, and has been adopted by the government to calculate welfare payments and pensions, thus reducing the burden of these expenditures on the State.

The Royal Statistical Society has calculated that the adoption by the government of CPI rather than RPI in calculating public service pensions will reduce their value by £30,000 over 25 years, assuming RPI of 3% and CPI of 2.33%

The Chancellor announced in his November 2017 Budget that CPI will also be used in future to peg business rates and determine annual investment limits for junior ISAs and trust funds, the capital gains tax exemption and the lifetime pension savings allowance, which will rise to £1,030,000 for 2018/2019. However, RPI is still used in determining rail fares, alcohol, student loans and index-linked gilts (government bonds).

To further complicate the issue, the government has now created a variant of CPI called CPIH (H for Housing). This includes the cost of renting a home but not the average mortgage payment. Consequently, it does not reflect variations in house prices. These are dealt with in yet another index.

People’s age, location and food preferences will all affect the impact of inflation. Pensioners will be affected disproportionately by increases in food and energy costs, and they are consequently less well served by CPI. People living in rural communities, on the other hand, will be more affected by the price of fuel, which is included in the RPI.

Most people will have little idea of which index relates most closely to their lifestyle, but it is the government which is best placed to play the system in what it regards as the national interest.


Interest rates are set to rise


The Bank of England has signalled its intention to raise interest rates, and other central banks, including the US Federal Reserve, are likely to be making a similar response to rising inflationary pressures. After years of easy money following the financial crisis ten years ago, they are concerned to prevent their economies from over-heating.

What does this mean for investors? The most direct impact will be on fixed-interest securities, or ‘bonds’. These are issued by both companies and governments which wish to raise money from investors. The capital is repaid at a fixed date in the future and meanwhile interest is paid at a rate which is fixed at the time when the bonds are issued.

Government bonds are known as gilt-edged securities or ‘gilts’, because repayment of the capital invested is guaranteed by the government.

Some government bonds are index-linked which means that the value of the capital repaid is linked to the Retail Prices Index, thus providing protection against inflation. However, most bonds lack this protection and the value of the capital repaid will be subject to erosion by inflation.

This threat to capital, combined with the low interest rates currently available from bonds, make them a poor investment at times like the present when inflation and interest rates are set to rise.

The best time to invest in bonds is when interest rates are high and set to fall. At such times bonds offer the attraction of higher interest rates than are available from deposits and greater security of capital than is available from shares.

However, apart from index-linked gilts (which can be expensive when inflation is on the rise), there are two types of bond investment which might be considered. 

First, strategic bond funds, whose managers have the flexibility to invest in all types of bond, both in the UK and internationally. Second, short-dated bond funds, which invest only in government bonds which are due to be repaid within the next 12 months, are the nearest alternative to cash deposits, but usually with a slightly more attractive interest rate.


Deferring retirement


Recent research by Dunstan Thomas among a sample of 598 baby-boomers showed that one in five of those surveyed, aged between 66 and 71, were still working full- or part-time and more than half respondents in the age group 55 to 71 expected to be working after State retirement age (65 for men and 64 for women).


Market timing


We maintain that a diversification strategy can help you achieve more consistent returns over time and reduce your overall investment risk.

The recent volatility has again sparked investor cries of “sell, sell, sell” as a knee jerk reaction to seeing global stock markets falling without really understanding the reasons behind such “corrections”.

Most investors prefer to be invested in actively managed funds run by a professional fund manager or investment research team who make all the investment decisions. The aim of active management is to deliver a return superior to the market as a whole or for conservative investment strategies, to protect capital and lose less money if markets fall. An actively managed fund can offer you the potential for higher returns than a market provides if the fund manager makes the right calls.

Passive investment funds simply track the market but charge less in comparison.  The funds are essentially run by computer and will buy all assets in a particular market and provide a return which reflects how the market is performing.

However, index funds provide no protection against market declines. If the index which is being tracked falls, so also does the value of a fund which tracks that index. By contrast, fund managers would hope to justify their fees by avoiding shares which might be most vulnerable to a sell-off.

Bearing in mind that stock markets do not usually move in unison, there might be advantage in switching from one index fund to another, though this would necessarily incur a charge.

A further disadvantage of index funds is they have no option but to invest in shares when their prices are high and therefore qualify for inclusion in an index, and to sell them when they fall in value, thus exposing the investor to the perennial danger of buying high and selling low.

There is a widespread view that the best of both worlds can be achieved by holding both actively managed funds and passive index funds within an investment portfolio - Index funds for timing the market and active funds for longer-term investment.

Which brings us back to the “mug’s game” and another oft-quoted observation, namely that successful investment depends not on timing the market, but on time in the market. Nick Train, a successful fund manager, counselled against over-active portfolio management with the words “don’t just do something: sit there”. Market-timers spend more on dealing costs and usually end up worse off than if they had stayed put.

There is a further, potentially more insidious, dimension to this debate, which was suggested as a possible factor behind the sharp correction suffered by markets last month. Namely, the increasing volume of indexed investment, combined with computer-generated activity, might exacerbate volatility and distort markets when they are no longer driven by the intrinsic value of the shares and bonds of which the indices are composed.

The active v passive debate continues, but there is no dissent from the view that investment portfolios, however composed, provide one of the best ways of accumulating wealth over the long-term. Though allocations should be tempered by John Galsworthy’s cautionary words – “moderation in all things”.


Dormant pensions grab


The government is considering including pension and insurance products in the scheme which it established in 2011 for diverting to charitable causes holdings in bank and building society accounts which have been dormant for at least 15 years.

It is estimated that between £400 and £500 million of funds could be involved, with a further £40 to £50 million added each year.

Assets would only be transferred after efforts had been made to identify savers and assist them to claim their assets; and if a claim were made after the money had been transferred, the owner would be in the same position as if the transfer had never taken place.


 Past performance is not a guide to the future. We would always stress that the value of an investment as well as any income derived can go down as well as up. This document does not constitute personal advice; please contact us if you wish to discuss the suitability of any of the investments outlined.