It’s not often that you can safe guard your money from the taxman and still seek to make a profit, but with an Investment ISA you can do just that. Here’s how to get started.
Investment ISAs offer a tax free home for your savings and the chance of more impressive returns than your average cash account. But with swathes of investment jargon and potential risk to your capital, many people are unnecessarily put off.
Here’s a beginners guide to Investment ISAs that’ll help you decide if you should take the plunge.
What exactly is an Investment ISA?
The big benefit of any ISA is that it protects your money from the taxman.
In any standard savings or investment account, you will have to pay tax on any interest you earn or profit you make. This is usually deducted automatically before you receive your gains.
An Investment ISA is essentially a tax free wrapper which can be placed around a variety of different investments to prevent you from having to pay tax.
Essentially money you invest is used, either directly or indirectly, to buy shares in the stock market. The performance of these shares will then determine if you make a profit and if so how much.
Ordinarily you would have to pay income tax on the income you earn from your investments and capital gains tax on the profit you make from selling shares. However, invest through an Investment ISA and you’ll receive any profit untaxed.
You must be at least 18 years of age to open an Investment ISA; however, the age threshold for most Cash ISAs is 16.
ISA Limits
There is a limit to the amount you can save through an ISA each year, the figures below are for the 2011/12 tax year (6th April 2011 – 5th April 2012):
You can save or invest a total of £10,680 in ISAs this tax year
Up to £5,340 of this can be saved in a Cash ISA
Whatever is left of your allowance can be put into an Investment ISA
So if you have put £3,000 into a Cash ISA, you can only invest up to £7,680 in an Investment ISA during the 2011/10 financial year.
What will you have to pay?
Investing in an Investment ISA does come at a price.
Unlike saving into a Cash ISA, if you opt to invest your savings into an Investment ISA you will have to sacrifice some of your capital in fees.
The reason for this is that the administration of Investment ISAs costs more to the providers than a relatively simple Cash ISA.
In most cases you will have to pay an initial deposit fee to cover the cost of buying the shares. This can vary significantly depending on the type of Investment ISA you choose but is usually around 2-5%.
After the deposit fee, you will also have to pay an annual maintenance fee; this is usually around 1-2% and is taken before your profits are paid.
As they can vary from account to account, remember to consider all the fees that you’ll have to pay when you compare Investment ISAs.
Should you invest?
Before looking at how to open an Investment ISA, you should strongly consider whether it would make better sense to put your cash elsewhere, or if you are moving other investments what fees you will have to pay.
Saving for the long term?
Investment ISAs should always be treated as a mid to long term investments and as a result shouldn’t be used in an attempt to make quick gains.
There are two main reasons for this: firstly although your returns through income from shares and profits are likely to be greater than the interest you’d get from cash over the long term, any capital in an investment can go up or down in value.
Secondly the amount you pay in fees for an Investment ISA will usually negate a significant part of your returns for at least a couple of years – although this will vary depending on how much you invest and where.
This is because the most significant expense you have to pay is likely to be the initial deposit fee of around 5% of your capital, followed by annual account fees on top of this.
Happy to take a risk?
All types of investment will leave your money exposed to a certain element of risk.
This means that you could get less money back than you initially invested if your account performs badly – although you can manage this to a certain extent through the type of ISA you choose or what areas of the market you decide to invest in.
Before investing, you should be happy to speculate with any money you put in an Investment ISA and accept that its value could go down as well as up.
Cash available
You shouldn’t invest money that you may need to access in the near future.
It’s usually reccomended that you have at least 3 months pay saved in cash before you consider investing – to prevent you from having to cancel an investment if you are faced with an unexpected bill.
Remember, because an Investment ISA is designed as a long term investment it’s unlikely that you’d be able to get your money out as quickly as from a cash account without losing out.
Ultimately you should only invest money you won’t need to draw on and are happy to speculate with.
Could it be put to better use?
If you have debts then it’s unlikely that choosing to invest will make the most of your money.
Even the best return on investments is unlikely to outweigh the amount of interest you would pay on unsecured borrowing such as a credit card or personal loan.
This means that you are likely to be better off using the money to pay off your debts instead of investing and looking again at investing once you’re debt free.
For more information read our guide: Should I Use my Savings to Pay Off my Debts?.
Self select or investment fund
Once you’ve decided that you want to invest, the next step is to decide how much involvement you want to have.
Investment ISAs tend to fall into two main categories: self select ISAs and investment fund ISAs.
Fund ISAs
Fund ISAs leave the buying and selling of shares to a fund manager, and work by pooling money into one large fund and investing this large amount of money across a number of companies.
This means that you don’t actively buy and sell shares but instead buy units or a share in an investment fund. Your money, along with the hundreds or thousands of other people’s money is then pooled together and used to buy shares in a wide range of companies.
Therefore, in theory at least, you have the clout of a much bigger investor and can reduce your risk by spreading your money across a wide number of markets, sectors and companies.
However, the annual fees for a fund based ISA are usually greater initially than a self select ISA as you are essentially paying the fund manager to manage your investment on your behalf.
That said, if you are a first time investor, or don’t feel confident buying and selling shares then choosing an Investment ISA that operates through a fund may be the most sensible choice.
Self select
The big advantage of a self select ISA is that it allows you to control exactly where you money is invested and the amount of risk you are exposed to.
However, because you essentially take the reins, they do tend to be better suited to people who have some experience in managing investments, perhaps having already having bought and sold shares in the past, and a clear idea which companies they want to invest in, rather than total novices.
If you are considering a self select ISA then you will also have to be willing to monitor your returns and the markets to check how your investments are performing and make any trades if necessary.
This is even more important because as you will only be investing in fewer companies than an investment fund, you will be exposed to a greater level of risk as your money isn’t spread so widely.
Compare ISAs
After deciding the level of involvement you want to have with your investment, you will have to decide exactly which type of ISA you want to opt for.
Choose a fund
If you want to invest through a fund you should compare those on the market to make sure you get the account best suited to your needs.
For help choosing a fund, read our guide: 9 Steps to Finding an Investment Fund That Will Maximise Your Profit
Select a self select
In the same way as comparing the various fund ISAs on offer, if you’ve decided to opt for a self select ISA then you can start to compare the different ISAs on the market.
Check exactly what areas each self select ISA will allow you to invest in; some are restricted to certain market sectors, while others may only allow you to buy shares from UK based or European companies.
You should also check the different fees applied by the various accounts, including deposit fees, trading fees and whether the account also applies a dormancy fee if you are inactive for a certain period of time.
The level of advice and guidance you receive will also vary between self select ISAs, some may recommend investments which you have to approve or reject, while execution only account will literally leave the decision entirely to you.
You can compare of the different self select ISAs using our self select comparison table.
Swapping or transferring ISAs
If you decide that you want to move your Investment ISA at a later date then you can do this. However, you can’t simply close your existing Investment ISA and deposit the money into a new Investment ISA.
In order you ensure that your tax free allowance is transferred with the money, you need to get your investment manager or company to transfer it directly to your new account.
This usually involves completing an ISA transfer form which is then send to the new account provider who makes sure that the money you are transferring doesn’t affect that year’s ISA allowance.
As such, if you are unhappy with your Investment ISA you can look to change your investments or switch to a different provider.
As with Cash ISAs, you can hold more than one Investment ISA but you are only allowed to pay into one each financial year.
You can, if you wish, move money from a Cash ISA to an Investment ISA without losing your tax free benefits, however you can’t transfer money the other way, from and Investment ISA to cash.
Additionally you can in some situations move existing investments within an ISA wrapper, so you get the tax benefits on the existing account, however, whether you are able to do this will depend on the type of investment account you hold.
For more help transferring your Cash ISA read the guide: How to transfer your Cash ISA
The Cupcake is a phenomenal example of how marketing can lure us into buying or investing in something that we would normally never touch.
The simple sponge cake was one of the first things I learnt to bake as a child; 4:4:4: and 2 eggs results in a bland and inoffensive cake. Of course the fun was not in the eating but in the mixing, spoon licking and decoration.
Given the choice as adults we wouldn’t touch them with a barge pole, they are pretty tasteless and very fattening. Strangely though in recent times they they have been adapted by marketing companies as the new wannabe gift, a symbol of love, the accompaniment for champagne and a delight to the eye. ‘The perfect little treat’! But Why?
The secret of course is in the presentation, its not the sponge cake we are attracted to but the decoration and sparkles on top, frosty icing, glittering balls, hand-piped messages and decorative cases. Pop 4 in a hand folded box and the deal is nailed. Serve with ice cool champagne for a fiver and we are hooked. Does cupcake and champagne even go together?
Like it or not the cupcake is selling, it’s everywhere.
The relevance to our investment choices is startling, only yesterday I was contacted by a land management company, they were selling plots of green belt land which were without planning permission. It’s a risky propossition with the potential for high return if planning permission is granted at a later stage.
Being a curious sort of person I asked for the brochure. The proposition the sponge, the brochure and presentation a decorative cupcake. An alluring piece of marketing that made it look like they were selling a to die for product when if fact it was just sponge.
Of course, there is a chance that you could buy a cupcake that actually tastes nice; that after all is the expectation. However, consider the reality. The right ingredients have to be measured, mixed and baked. The cake has to be fresh, soft, light and the flavour superb.
Let’s face it when you have recovered from the appeal of its appearance most cupcakes taste pretty dull and ordinary. Come on its just a sponge.
The fact that pretty ordinary deals are wrapped expertly in glittering packages is a phenomena investors have to think about carefully.
What you should be doing is stripping off the icing and then decide if you would still buy the cake.
You could argue that the icing adds an intrinsic value to the product which could facilitate an emotional response but, well worth a couple of £’s, this argument wouldn’t hold much water though if you were shelling out 10′s of £000′s on a piece of land.
The message, beware the marketeer he is a clever and often devious character and is the reason that the following saying was coined. ‘If it looks too good to be true it probably is’.
Sadly Value for Money opportunities rarely come in Technicolor; they are far more likely to present in a paler shade of grey.
On so many levels exposure to the risk of poor Investment can bring even the wisest Investor to their knees.
Offices bursting at the seems with financial analysts lay testament to the fact that constant monitoring cushions Corporate Investors from poorly performing investments; even so, they don’t always get it right.
As a non Corporate investor, you don’t necessarily have the same sort of analytical resource,but that shouldn’t mean you don’t analyse the proposition.
So what do you do?
Many claim they have a gut feeling about their deals feeling confident to rely on fag packet calculations to support their decision making. In a rising market this philosophy may have been supportable, despite it being just a tad unscientific. The credit crunch has brought with it fresh challenges and even if you are happy with the fag packet calcs., the financiers won’t be.
Financial modelling employs a variety of scenarios all of which may or may not happen. It’s a common sense approach to developing decision making tools that anyone can use.
1. Start with research; pick your property, shares or uncut diamonds whatever it is that floats your boat. Determine the value at today’s cost.
2. Consider additional costs; refurbishment costs, development costs, acquisition costs and legal costs, everything you can think of that will make your asset rentable, sellable or storable.
3. Consider ongoing costs; insurance, maintenance & overheads.
4. Then look at the income; it may be dividends, rent or interest.
[ Remember for property always factor in void periods, the shorter the lease the longer the void periods are likely to be. For example it might be prudent to only include 40% of city letting income; where accommodation is let daily, unless you have proof that you can do better than this. For a 6 month shorthold tenancy, assume at least one month a year will be void. With commercial property the lease may be longer but don’t assume you will let straight away especially in today’s market. A prudent investor would establish this type of tenancy before buying the investment.]
That’s the straightforward part ‘Income and Expenditure’ cash flow.
If you can imagine these figures in a spreadsheet you could handsomely demonstrate that your proposal stood a chance of making you money or conversely not; at least in this case it gives you the option to walk away before it’s too late.
Now we have to consider different scenarios.
The easiest to envisage at the moment is an increase in interest rate.
It’s reasonable to assume that interest rates will rise in the next 2 years however, it’s anybody’s guess by how much and when.
It could however, firmly put the scuppers on your plans.
A rise in interest will change the ongoing costs of borrowing. Therefore build in a rate rise of varying degrees and see what happens to your cash flow analysis.
What if a commercial tenant were to exercise a break at year 5 in your plan, how long would you be without rent, what if this scenario coincided with your worst expectation of interest rate rise.
What if a major employer in the city suddenly went bust leaving your buy to let investments unoccupied for long periods, a flood, a fire maybe; the list goes on?
Some of the mentioned events are possible, but unlikely. These types of occurrences can usually be insured against and let’s face it, insurance makes sense; you can’t think of everything.
Whether it’s a £50,000 or £50,000,000 investment, financial modelling will help you demonstrate to lenders that you have considered the possibility of change into the model. If your cash flow remains good despite worst case scenario then it’s a goer.
Once you are happy with a workable budget you can then concentrate on the actual value of your proposition, factoring in growth on the plus side and inflation on the negative you can work this back to a Net Present Value (NPV)
What Does Net Present Value – NPV mean?
The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.
NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield.
Investopedia goes on to explain that
NPV compares the value of a pound today to the value of that same pound in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.
You might not be able to go all the way with this, but at the very least you should attempt the first part, it’s a common sense fairly straightforward way to assess whether your next big deal really represents ‘Value for Money’.
There was time when you could confront a Lender with a ‘squeaky clean’ past, utility bills would be proof of residence and your bank account status and previous loan history would be enough to reassure the Lender that you were an honourable prospect.
Those days are gone forever; Innocents are now branded by the Credit Score companies.
Having an Investment aspiration; a new house, Business venture a new job even, is no longer enough. You’ve probably heard it said ‘want something enough..go for it’
NOT SO, nowadays you have to hop the Credit Score hurdle first.
We are no longer judged by what we have done right, rather what we have done wrong or in some case what we have failed to do.
Thinking of yourself as a ‘good credit risk’ with honest knowledge that you have always played by the rules is a mistake. Simply put you are deluded.
If you are applying for a job in Financial Services, a Store or Credit Card, opening a Bank Account or considering a Loan or Mortgage application be warned. Your Credit Score/Report will be accessed as a matter of course. If you don’t make the grade……FACT you will not get that job, credit card, loan, mortgage get the picture. It hurts.
Action Stations
• Get a copy of your Credit Report (and remember its updated regularly so will be out of date within a matter of months).
• Check it for errors. If there are errors and, believe me it’s more common than you might like to think. Work on getting them corrected. It’s not fair I know and, you will have to provide proof which can be a frustrating process. Persevere it will pay dividends in the end.
Remember this document could be and often is the deciding factor that determines what happens next in your life.
So what can you do?
1. If your Credit Report says you are not on the Electoral Role then get on it immediately. Contact the Electoral Office in your area and ask for the application form and/or ask them to send you a letter confirming that you are on the role. It may take time but it’s worth it. You can then get The Credit Report Company to change your file. Lenders always ask how long you have lived at your current address; they prefer permanence it’s understandable. While your application wouldn’t be turned down on the basis of the Electoral Role it’s just one of the factors that can damage your overall Credit Score.
2. Don’t be late with Credit/Store card payments. Set up a monthly Direct Debit to pay off at least the minimum payment every month. If you are late it will be recorded on your Credit Report, while once is acceptable twice is not, it will affect your Credit Score and will trigger an Amber alert on your record, which could then take months to drop off.
3. The same applies if you are late with loan or Mortgage payments; if you think you may be unable to make a repayment on time contact the Lender before the event occurs. They may allow some leeway which will buy you time and save your reputation. (obviously this won’t work if you demonstrate it as a habit) To reiterate, ALWAYS CONTACT THE LENDER. If it was your money you would want to know what was happening.
4. Not having Credit Cards or a history of Credit can be as bad as having too much or paying late. Having Credit Cards and not using them will also do you no service. The best strategy is to have at least one Credit Card in your own name, use it periodically and always pay at least the minimum each month.
5. Do Not apply for Credit until you know you have a ‘Good Credit Score’ (company sites for example Experian or Equifax will explain what this is), every unsuccessful application you make for Credit will effectively reduce your score and compound the possibility of being rejected. Individuals who apply for Credit repeatedly will be considered a poor risk by Lenders as it indicates that other Lenders have rejected them.
Dream of that Investment by all means BUT..
Before you do anything, sort out your Credit Score or be Damned alternatively join thousands of people who are spiralling towards a black hole of rejection.
Like it or not we are stuck with the system.
There are plenty on companies on the web that will take your money for the report, do your research and choose one that gives the service you require.
Good Luck
£5 in the Pig £15 on a Buy to Let Mortgage
So, how is buying a property to rent different from buying a home to live in? The property price is of course the same but the type of funding available to purchase a Buy to let is different. Why? Because it carries more risk for the lender.
As an independent Mortgage Broker I have access to 30 lenders who combined are presently offering hundreds of deals for Buy to Lets Fixed and Tracker rates from 3.19% over base. The Lenders require capital of between 25-50% of the property value. They will also want you to demonstrate that rents of 125% are achievable. Obviously the less risk the lender is exposed to the better rate you will be able to get.
You may have heard stories about investing in Buy to Lets with ‘No Money Down’; strictly speaking this practice is illegal and frowned upon by lenders and the FSA and is one of the reasons so many property owners are now in financial difficulty.
The moral of the tale is if you are going to borrow money to buy property do it sensibly, treat tenants fairly and keep your property in a good state of repair. If you have confidence in the market and your ability as a Buy to Let Landlord then in the long term you will be rewarded handsomely.
To summarise you will need:
At least a 25% deposit.
Rents in excess of 125% of Mortgage repayments.
To demonstrate that you are a Credible Landlord (this may be evidence that you have already succeeded in the industry or that you have a business plan which clearly sets out how you are going to manage the property) or that you will be using an ARLA (Association of Residential Letting Agents) accredited property agent.
Although lenders don’t usually require it, it’s always a good idea to protect any loans you take out in case of the unexpected happening. For example you may become ill or even die unexpectedly and be unable to manage your portfolio, leaving your nearest and dearest responsible for repayments and management. For the sake of an extra few pounds a month much of the risk can be insured against.
The other factor that affects investors is the ongoing and terminal Tax considerations of Buy to Let Investments.
In the short term all rents are treated as income and should be declared on a Inland Revenue Self Assessment tax form within the property pages. The good news is that expenses of the letting business can be offset against the rent, for example:
Mortgage interest
Agents fees
Repair and maintenance Costs
On disposal of the property any Capital Gain (the difference between the buying and selling price less certain costs) is subject to Capital Gain Tax. There is now a single tax rate of 18% of the Gain. However in each tax year (April –April) individuals are entitled to make a Capital Gain of £10100 (2009/2010) before any gains are subject to Tax, it follows that if an investment is in joint names the entitlement increases to £20200 as two personal allowances are due. There are also special rules in place where you have personally lived in a property before disposal. For more information on Tax issues the Inland Revenue’s website http://www.hmrc.gov.uk is a great source to delve into.
Now you have read my Buy to Let Blogs do the Buy to Let Quiz.
Helen Clover- Edinburgh, UK
