The 3 stages to money success (part 3: investing wisely)
When we think about money success, investing feels like it should be the first port of call. However, getting step 1 and 2 ticked off should be your top priority ahead of this step.
When it comes to investing, there are three main areas you should be thinking about. Tax, risk management and your personal objectives.
We obviously pay tax on anything we earn, but we also pay tax on some savings and investments. So any interest you earn will be added to your overall earnings and taxed accordingly. For some people, this can of course mean a 40% hit on any interest they earn.
Because of this, it’s important to shield as much of your savings from tax as possible (not in a naughty way of course!). A good example of this is an ISA, as any growth or interest earned is completely tax free.
The same goes for pensions. In fact, pensions also benefit from tax relief at outset. So, if you're a basic tax payer, for every £80 you put in, the government will give £20. For a higher rate taxpayer, for every £60 you put in the government will give £40. There may be income tax to pay later in life when you draw the pension, but it can grow tax free for many years before this happens.
It doesn’t affect many, but one thing to consider are the annual limits. ISAs in the 2020/21 tax year are limited to £20,000 per year and pensions are 100% of earnings, up to £40,000.
If you are in a position to save more than this, due to an inheritance, or business sale perhaps, there are other options available such as venture capital trusts, enterprise schemes and business relief funds. These are higher risk investments, but offer quite lucrative tax incentives.
Risk Management & Objectives
This can sound a bit scary, but the reality is unless you’re planning on actively trading your own shares, you don’t need to know the ins and outs of risk management.
What is important is your personal attitude to investment risk, how much you can afford to lose and when you need access to the money. Knowing the answers to each of these can ensure that your savings and investments are perfect for you and your personal objectives.
A financial adviser will help establish all of these things for you, but here are some general rules to abide by when it comes to risk.
If you need access to the money in the next 5 years capital protection is important. Say for example you’ve saved for an extension on your house and you’re just about to start the work. You’ve opted to be in a higher risk investment and the market crashes (or a global pandemic hits!) just before the work starts. Unless you have other savings, you're now in a position where you have to delay the extension until the market recovers, or take on more debt to cover the shortfall. Having lower risk investments like bonds and gilts would have provided capital protection as well as some returns.
Don’t take more risk than you are comfortable with. Sometimes it can be tempting to take more risk, as it has, over the long run lead to greater returns. However, it can be a bumpy road and taking levels of risk higher than you are comfortable with can lead to unnecessary stress and anxiety.
Play the long game. Long term strategies in most aspects of our lives can provide big rewards - this is especially true of investing and financial planning. Creating a financial life plan and keeping on top of it can help you create the lifestyle you want. If you want to know a little more about financial life planning, check out this guide.