Behavioural finance has an increasingly central part in conversations about investment risk, since managing emotional responses plays a key role in maximising returns.
Unfortunately, wealth can be all-too transient, so first take steps to protect the money you have accumulated from common dangers.
You may have accumulated wealth through your career, selling a business, inheritance or otherwise receiving a lump sum. Your first job is to protect that wealth.
We often find that the affluent individuals using our service are “cash heavy”, unsure of what to do with a large amount of money or believing that cash is the safest way to hold wealth.
There may good reasons to keep at least some of your wealth in cash form (at least in the short term), perhaps in a simple savings account with a bank.
Here, you need to be aware that cash deposits are only protected under the UK regulator’s Financial Services Compensation Scheme up to £85,000 per account-holder for each institution (the limit for joint accounts is £170,000). This means that you may need to spread your deposits among several institutions to maximise your protection and look carefully at whether you hold money with several institutions that operate under the same banking licence.
Never place your money with an institution that is not regulated to the highest standards, particularly if placing money abroad.
While cash might feel “safe”, the reality is it might be anything but due to the erosive power of inflation. If your money is not growing at a rate that at least matches inflation then in reality you are losing spending power over time.
Although it is completely reasonable to be risk-averse, clinging to cash can be hugely self-defeating – particularly in a world of low interest rates.
Most High Street banks have offered minimal interest for some years now, even for ISA accounts and fixed-term deposits. However, those with significant amounts to invest can access very much more attractive rates through a (fully regulated and reputable) private bank or wealth manager. If this is your situation, please let us know when beginning your search for a provider.
To lessen the risk of inflation eating away their wealth, most investors should explore alternative safe havens for their capital.
Fixed-income investments (bonds) are also viewed as being safe investments yet, just as with cash, inflation erodes the real value of the principal investment and the coupon payment.
Property is also considered to be a risk-free way to hold wealth, yet wavering prices give the lie to the phrase “safe as houses”. Property also needs maintenance and can carry hefty tax liabilities, particularly in the case of second properties/buy-to-lets.
Precious metals and tangible assets like collectibles and cars also present real issues around storage, insurance and price volatility, so should never be used as the main store of value for your wealth.
There are numerous options for even the most cautious individuals, many of which are quite close to cash in risk terms yet may offer far more attractive returns (short-term bonds, money market funds and bond funds to name but a few). You can also choose to have different risk exposures for different pots of money.
Once the right protections are in place you should look to grow your wealth, making sure that you are maximising reward and minimising risk.
Most people will need to take on at least a modest amount of investment risk to really protect their wealth and achieve their financial goals. The more you seek short-term safety through holding large amounts of cash, the more you risk missing out on the security of long-term returns.
Equities are far higher up the risk spectrum, but they are certainly where investors should seek real outperformance. According to the Barclays Equity Gilt study, the longest-running in the industry, equities have outperformed cash in all time periods. Over the last 50 years, UK equities have generated 5.7% per year in real terms, net of inflation, against just 1.5% for cash.
Share prices might rise and fall frequently, but those with time on their side can ride this volatility out. Also, bear in mind that reinvesting the dividends from equity investments can power up your portfolio returns to a very great degree.
While equities convincingly beat most other asset classes over the long term, that certainly does not mean you should allocate the majority of your wealth to them. A 60/40 equities to bonds ratio used to be the traditional wisdom, but this could represent too much equity volatility or risk for some investors; it may also be too heavily weighted to bonds if inflation accelerates.
Moreover, even fairly modest investors can benefit from diversifying into a far broader set of asset classes and instruments today than just equities and bonds.
Having an intelligent mixture of asset classes – in the right proportions – will help ensure your portfolio delivers the expected level of returns while minimising risk. The key is to arrive at the optimal mix for your time-horizon, risk-profile and objectives (which may include decreasing your tax bill, as discussed below).
Many would-be investors hold back from investing because they are waiting for the right time, but the truth is that it is next to impossible to time the markets with any great degree of accuracy. (There are times, however, when it is a great opportunity to get into certain markets or assets, and identifying these is where a wealth manager can really add value.)
In truth, what most investors regret is staying on the side-lines and so not benefitting from market growth. Because of the magic of compounding returns, investing just a few years earlier can make a significant difference to your eventual position (and a huge one if a decade or more).
Also bear in mind that you can “drip-feed” your money into the markets, an approach which works just as well for nervous investors as those who wish to invest sums on a regular basis, such as by making monthly contributions to a Self-Invested Pension Plan (SIPP).
Keeping your tax exposure as low as possible is just as important to achieving your financial goals as seeking robust investment returns, and taking advice at the right times can save you huge amounts.
The government offers several tax-wrappers which will shelter your investments from tax and you must make sure that every member of the family is maximising their use of these (even children) each and every year.
ISAs (and their Junior equivalents) are a great way to grow your wealth and reduce your tax liabilities. As of 2017/19 adults can put £20,000 aside each year into cash, stock and shares, or a mixture of the two, protecting interest/gains from income tax; Junior ISAs allow for under-18s to have up to £4,128 saved or invested on their behalf annually.
Similarly, SIPPs are an excellent way to secure tax reliefs on your pension contributions (an automatic 20% at the basic rate, while higher-rate taxpayers can claim a further 20% and additional rate tax-payers another 25%). SIPPs can offer tax-efficiencies at both the accumulation and decumulation stage and are an attractive way to hold many assets. Contribution limits do apply, however, and professional advice is always warranted.
Many investors are not aware several types of tax-efficient investment exist with government support which may reduce your tax bill in myriad ways.
Investors willing to back smaller UK companies can utilise Enterprise Investment Schemes to gain very attractive reliefs against income and Capital Gains taxes, while investments coming under the Business Property Relief regime can also help slash Inheritance Tax bills.
Tax-efficient investments do sit higher up the risk spectrum than more traditional ones, but can offer very attractive returns as well as significant tax benefits. They are often also very interesting investment opportunities, such as film production or forestry. They are a complex area, however, and call for professional investment and tax-planning advice.
Tax should be a lens to view all your wealth through. You should deploy all legitimate means to protect your wealth from it and happily there are a great many.
Saving on tax might concern (seemingly) small matters, or large ones, and how you invest (and hold) money can be as important as what you invest in.
For instance, Open-Ended Investment Companies and Unit Trusts can allow for tax-efficient investment through the exploitation of your Capital Gains Tax allowance. One of the very significant – and underappreciated – ways a wealth manager will help build your wealth is by ensuring you are always investing in the most cost- and tax-efficient manner (they can offer institutional fund classes, rather than the more expensive retail ones DIY investors are limited to).
At the other end of the spectrum, families with very significant wealth might look to structure it in tax-efficient ways so that as much passes to the next generation as possible.
A professional adviser will be able to bring to bear tax and investment expertise from across their entire organisation (or even bring in outside experts) to ensure that your whole financial plan is optimised.
Get a comprehensive plan into place
This guide outlines just a few of the ways you should be looking to protect and grow your wealth – while also keeping a constant eye on your tax liabilities. With a full appraisal of your circumstances and objectives in the short, medium and longer term, a professional wealth adviser will be able to suggest a range of strategies and techniques to get – and keep – you where you want to be.
Our smart online tool will match you to the best-matched wealth managers for your needs and if you require financial planning or tax advice in addition to investment management, simply indicate this when inputting your details.
Alternatively, if you would like an informal discussion of your needs with our expert team, please get in touch.