Investmen tbonds

Investment bonds are designed to produce medium- to long-term capital growth, but can also be used to give you an income. They also include some life cover. There are other types of investment that have ‘bond’ in their name (such as guaranteed bonds, offshore bonds and corporate bonds), but these are very different. You pay a lump sum to a life assurance company and this is invested for you until you cash it in or die.

Investment bonds are not designed to run for a specific length of time but they should be thought of as medium- to long-term investments, and you’ll often need to invest your money for at least five years. There will usually be a charge if you cash in the bond during the first few years.

The bond includes a small amount of life assurance and, on death, will pay out slightly more than the value of the fund. Some investment bonds offer a guarantee that you won’t get back less than your original investment, but this will cost you more in charges.

You can usually choose from a range of funds which can invest in, for example UK and overseas shares, fixed interest securities, property and cash. They can also offer a way of investing in funds managed by other companies, but this may lead to higher charges.

Investment risk can never be eliminated but it is possible to reduce the ups and downs of the stock market by choosing a range of funds to help you avoid putting all your eggs in one basket. Different investment funds behave in different ways and are subject to different risks. Putting your money in a range of different investment funds can help reduce the loss, should one or more of them fall.

You can usually switch between funds. Some switches may be free, but you may be charged if you want to switch funds frequently. Any investment growth at the time of a fund switch is not taxable.

Any growth in investment bonds is subject to income tax. The investment will pay tax automatically while it is running so, if you are a:

non-taxpayer – you will not have to pay any further income tax but you cannot reclaim any tax;

basic-rate taxpayer – you will not normally have to pay any further income tax; and

higher-rate taxpayer (or close to being one) – if you withdraw more than 5 per cent of the original investment amount in a year or you have made a profit when you cash in the investment, you may be liable for more income tax.

Depending on your circumstances, the overall amount of tax you pay on investment bonds may be higher than on other investments (like a unit trust, for instance). But there may be other reasons to prefer an investment bond. Or you may want to set up the investment within a trust as part of your inheritance tax planning (but note that you normally lose access to at least some of your money if you do this).

You can usually take out some or all of your money whenever you wish but there may be a charge if you take money out in the early years.

You can normally withdraw up to 5 per cent of the original investment amount each year without any immediate income tax liability. The life assurance company can pay regular withdrawals to you automatically. These withdrawals can therefore provide you with regular payments, with income tax deferred, for up to 20 years.

Inflation matters

Even though the economy has been experiencing deflationary pressures, investors should be very mindful of the return of inflation and the need to factor this into their future plans. Even though inflation may take longer to reach the government’s two per cent target, once there, it could start to rise quickly. As we know, prevention is always better than cure, so what should you be considering today to protect yourself from the return of inflation tomorrow? 

Currently, if you receive income from cash or gilts (government bonds) you could see this income in real returns fall considerably with the return of inflation. One prevention measure would be index-linked gilts, offering yields that rise in line with inflation. However, depending on the level of inflation, it may be more appropriate to hold conventional gilts instead. Alternatively, savings certificates from Treasury-backed National Savings and Investments (NS&I), also guarantee to beat inflation. They pay a tax-free percentage over RPI over three or five years.

If you are planning to retire over the next few years you may consider exchanging your pension fund for a level-term annuity that will pay you a fixed monthly sum for life. But if you have concerns about the effects of rising inflation during your retirement and the impact this would have on your standard of living, you could purchase an annuity that increases in line with the retail price index (RPI). If this is the route that you decide to take you need to be aware that this option will initially provide a lower starting payment than a level annuity. An alternative is to split your fund and purchase a level annuity with one half and an RPI-linked product with the other.

The value of investments and the income from them can go down as well as up and you may not get back your original investment. Past performance is not an indication of future performance. Tax benefits may vary as a result of statutory change and their value will depend on individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent finance acts.

Investment objectives – a lifelong process

Protecting your wealth from market ups and downs

A lifestyle financial plan has no value unless it is properly implemented through an appropriate investment strategy. If you’ve got a sufficient amount of money in your cash savings account – enough to cover you for at least six months – and you want to see your money grow over the long term, then you should consider investing some of it.

Investing is a lifelong process, and the sooner you start, the better off you may be in the long run. Regardless of the financial stage of life you are in, you will need to consider what your investment objectives are, how long you have to pursue each objective, and how comfortable you are with risk.

Right savings or investments
The right savings or investments for you will depend on how happy you are taking risks and on your current finances and future goals. Investing is different to simply saving money, as both your potential returns and losses are greater.

If you’re retiring in the next one to two years, for example, it might not be the right time to put all of your savings into a high-risk investment. You may be better off choosing something like a cash account or bonds that will protect the bulk of your money, while putting just a small sum into a more growth-focused option such as shares.

More conservative investments 
You may be a few months away from putting down a deposit on your first home loan. In this case, you might be considering cash or term deposits. You might also choose a more conservative investment that keeps your savings safe in the short term.

On the other hand, if you have just recently started working and saving, you may be happy to invest a larger sum of your money into a higher-risk investment with higher potential returns, knowing you won’t need to access it in the immediate future.

Different investment options
If appropriate, you should consider a range of different investment options. A diverse portfolio can help protect your wealth from market ups and downs. There are four main types of investments, also called ‘asset classes’, each with their own benefits and risks.

These are: 
Shares – investors buy a stake in a company
Cash – savings put in a bank or building society account
Property – investors invest in a physical building, whether commercial or residential
Fixed interest securities (also called ‘bonds’) – investors loan their money to a company or government

Defensive investments
Defensive investments focus on generating regular income as opposed to growing in value over time. The two most common types of defensive investments are cash and fixed interest.

Cash investments include:

High interest savings accounts
The main benefit of a cash investment is that it provides stable, regular income through interest payments. Although it is the least risky type of investment, it is possible the value of your cash could decrease over time, even though its pound figure remains the same. This may happen if the cost of goods and services rises too quickly (also known as ‘inflation’), meaning your money buys less than it used to.

Fixed interest investments include:

Term deposits, government bonds, corporate bonds
A term deposit lets you earn interest on your savings at a similar, or slightly higher, rate than a cash account (depending on the amount and term you invest for), but it also locks up your money for the duration of the ‘term’ so you can’t be tempted to spend it.

Bonds, on the other hand, basically function as loans to governments or companies, who sell them to investors for a fixed period of time and pay them a regular rate of interest. At the end of that period, the price of the bond is repaid to the investor.

Although bonds are considered a low-risk investment, certain types can decrease in value over time, so you could potentially get back less money than you initially paid.

Growth investments
Growth investments aim to increase in value over time, as well as potentially paying out income. Because their prices can rise and fall significantly, growth investments may deliver higher returns than defensive investments. However, you also have a stronger chance of losing money.

The two most common types of growth investments are shares and property.

At its simplest, a single share represents a single unit of ownership in a company. Shares are generally bought and sold on a stock exchange.

Shares are considered growth investments because their value can rise. You may be able to make money by selling shares for a higher price than you initially pay for them.

If you own shares, you may also receive income from dividends, which are effectively a portion of a company’s profit paid out to its shareholders.

The value of shares may also fall below the price you pay for them. Prices can be volatile from day to day, and shares are generally best suited to long-term investors, who are comfortable withstanding these ups and downs.

Although they have historically delivered better returns than other assets, shares are considered one of the riskiest types of investment.

Property investments include:
Residential property such as houses and units
Commercial property such as individual offices or office blocks
Retail premises such as shops or hotels
Industrial property such as warehouses

Similarly to shares, the value of a property may rise, and you may be able to make money over the medium to long term by selling a house or apartment for more than you paid for it.

Prices are not guaranteed to rise though, and property can also be more difficult than other investment types to sell quickly, so it may not suit you if you need to be able to access your money easily.

Returns are the profit you earn from your investments.

Depending on where you put your money, it could be paid in a number of different ways:
Dividends (from shares)
Rent (from properties)
Interest (from cash deposits and fixed interest securities)

The difference between the price you pay and the price you sell for – capital gains or losses.