Navigating your way around a wide range of investment products and strategies
In a period of slow global growth, aggressive central bank actions and near paralysis on the part of many fiscal policy makers, investors enter 2013 facing a plethora of challenges.
There are three main hot topics that are likely to impact on making investment decisions over the next 12 months: China, the US and the Eurozone. Chinese monetary policy-making by the new leadership needs to tread a fine line between slowing economic growth, which could cause social unrest, and creating asset bubbles. A US debt ceiling breach around March 2013 could lead to draconian consequences if an agreement is not reached. Finally, the on-going Eurozone sovereign debt crisis – although steps have been taken in the right direction, Europe is still not fixed.
Good financial planning
Navigating your way around the plethora of investment options out there can be very daunting and requires professional financial advice. Before investing, you need to ask yourself a basic question. What are you investing for? Good investment requires good financial planning first of all. You must decide what your objectives are, what return you need to achieve that objective and what risk you are willing to take to achieve that return.
Deciding how much to invest in equities, fixed interest (gilts and corporate bonds), property and cash is the first step in constructing a portfolio. Many investors are understandably nervous about taking risks with their hard-earned capital during this current period but not taking enough risk can be just as damaging as taking too much.
Taking a long-term view
All asset classes carry risk – including cash, which can lose its spending power over time because of inflation. Most investors see risk as the risk of short-term price falls but fail to consider the risk that their investments will not grow fast enough to meet their objectives. Those who can afford to take a long-term view and see their capital fluctuate in value could consider taking more risk to try and achieve an inflation-beating return.
Shares are different from most goods in that demand often increases as prices rise. If an investment area is fashionable, it could be a sign that it is overvalued. Traditional areas, such as blue chip companies, often generate the best long-term returns, so it makes sense for most investors to avoid the latest fad. However, it is important to remember that all stock market investments will fluctuate in value, so you could get back less than you invest.
Maximum use of tax shelters
Investors also need to make the maximum use of tax shelters as tax can eat away at your returns. These can include pensions and Individual Savings Accounts (ISAs) at one end of the spectrum to Enterprise Investment Schemes and Venture Capital Trusts at the other, higher-risk end.
Even following the proposals announced by the Chancellor, George Osborne, concerning pension tax relief in his Autumn Statement, pensions still offer very attractive tax benefits through the income tax relief you receive on the contributions.
In the current 2012/13 tax year, there is no tax to pay within an ISA on any capital gains and no further tax to pay on any income and you can shelter up to £11,280, which is set to rise to £11,520 from 6 April this year.
Having said this, making an investment decision based on a tax saving alone should not be the main consideration at the expense of the other rules of investing.
Different areas perform well at different times
An undiversified portfolio will only perform well some of the time. Good examples of this are the banking crisis of 2008 and the technology crash of 2000 – many investors who were over-exposed to these areas suffered heavy losses. Diversification mitigates risk, as different areas perform well at different times. Paradoxically, though, it’s also important not to be too diversified.
One of the biggest dilemmas investors face is market timing. Jumping in and out of markets on a regular basis not only requires constant monitoring of daily events but also requires the skill to act on such events. The return from a lump sum investment can depend heavily on the entry point. One way to achieve this is to spread or drip-feed a lump sum into the market as opposed to investing it all in one go. In fact, during volatile times this strategy allows you to benefit from what is known as ‘pound cost averaging’. Regular investing provides an alternative method of building positions over time.
Information is based on our current understanding of taxation legislation and regulations. Levels and bases of and reliefs from taxation are subject to legislative change and their value depends on the individual circumstances of the investor. The value of your investments can go down as well as up and you may get back less than you invested.