Time to aim for higher returns


A round two fifths (41 per cent) of UK adults are currently investing in Cash ISAs. However, less than one in ten (9 per cent) are investing in Stocks & Shares ISAs, despite low interest rates meaning that even tax-efficient Cash ISAs could be struggling to keep pace with inflation.

Reviewing your approach
With the Monetary Policy Committee (MPC) continuing to keep interest rates low and inflation relatively high, cash held in an ISA or a savings account could be eroded in real terms. So now might be worth reviewing your approach and, if appropriate, considering whether you could take more risk with some of your cash. You could potentially invest in the stock market instead, through a tax-efficient Stocks & Shares ISA, to try to beat inflation. However, it’s always sensible to keep some money in cash, where it is safe and you can get instant access to it.

Consider your options
For those individuals willing to take more risk with a proportion of their money, there is the option to consider using as much of the current annual £11,520 (2013/14) Stocks & Shares ISA allowance as they can this tax year. The annual ISA allowance is per individual. This means that a husband and wife, or registered civil partnership, for example, can invest up to £23,040 between them into ISAs this tax year.

The research from Standard Life (08 April 2013) also reveals men and women take a very different approach to their investments. Over one in ten (12 per cent) men currently save into a Stocks & Shares ISA, compared to only just over one in twenty (6 per cent) women. An equal percentage of men and women are currently saving into Cash ISAs (41 per cent for both).

ISA matters
Use as much of your current £11,520 (2013/14) ISA allowance as possible in this tax year. You can invest this full amount in a Stocks & Shares ISA so you have the chance of greater tax-efficient growth over the longer term. Investing regularly each month can help to smooth out any short-term ups and downs in the stock market.

Review your Stocks & Shares ISA investment regularly to make sure it is performing as expected. Reinvest to help generate more income. Remember that if you choose an ISA that generates income, you can reinvest this money as well as paying it into a bank account. This means you have the opportunity to continue to generate income based on your long-term investments.

Source: All figures, unless otherwise stated, are from YouGov Plc. Total sample size was 2,059 adults. Fieldwork was undertaken between 25-28 January 2013. The survey was carried out online. The figures have been weighted and are representative of all UK adults (aged 18+).

Past performance is not necessarily a guide to the future. The value of investments and the income from them can fall as well as rise as a result of market and currency fluctuations and you may not get back the amount originally invested. Tax assumptions are subject to statutory change and the value of tax relief (if any) will depend upon your individual circumstances.

Spreading risk in your portfolio

Diversification helps lessen what’s known as ‘unsystematic risk’, such as reductions in the value of certain investment sectors, regions or asset types in general. But there are some events and risks that diversification cannot help with – these are referred to as ‘systemic risks’. These include interest rates, inflation, wars and recession. This is important to remember when building your portfolio.

The main ways you can diversify your portfolio

Having a mix of different asset types will spread risk because their movements are either unrelated or inversely related to each other. It’s the old adage of not putting all your eggs in one basket.

Probably the best example of this is shares, or equities, and bonds. Equities are riskier than bonds, and can provide growth in your portfolio, but, traditionally, when the value of shares begins to fall bonds begin to rise, and vice versa.

Therefore, if you mix your portfolio between equities and bonds, you’re spreading the risk because when one drops the other should rise to cushion your losses. Other asset types, such as property and commodities, move independently of each other and investment in these areas can spread risk further.

Once you’ve decided on the assets you want in your portfolio, you can diversify further by investing in different sectors, preferably those that aren’t related to each other.

For example, if the healthcare sector takes a downturn, this will not necessarily have an impact on the precious metals sector. This helps to make sure your portfolio is protected from falls in certain industries.

Investing in different regions and countries can reduce the impact of stock market movements. This means you’re not just affected by the economic conditions of one country and one government’s fiscal policies.

Many markets are not correlated with each other – if the Asian Pacific stock markets perform poorly, it doesn’t necessarily mean that the UK’s market will be negatively affected. By investing in different regions and areas, you’re spreading the risk that comes from the markets.

Developed markets such as the UK and US are not as volatile as some of those in the Far East, Middle East or Africa. Investing abroad can help you diversify, but you need to be comfortable with the levels of risk that come with them.

It’s important not to invest in just one company. Spread your investments across a range of different companies.

The same can be said for bonds and property. One of the best ways to do this is via a collective investment scheme. This type of scheme invests in a portfolio of different shares, bonds, properties or currencies to spread risk around.

Beware of over-diversification
Holding too many assets might be more detrimental to your portfolio than good. If you over-diversify, you may be holding back your capacity for growth as you’ll have such small proportions of your money in different investments that you won’t see much in the way of positive results.

Reducing the overall level of investment risk


To avoid concentrating risk, it is important not to ‘put all your eggs in one basket’ by investing in just one share or in one asset class. If appropriate to your particular situation, spreading capital across different shares and different asset classes can reduce the overall level of risk.

Funds are typically seen as a way to build up a lump sum of money over time, perhaps for retirement, but they can also be used to provide you with a regular income.

Type of income funds
There are four main types of income fund:

Money Market Funds – pay interest and aim to protect the value of your money.

Bond (Fixed Income) Funds – pay a higher rate of interest than cash deposits, but there is some risk that the value of your original investment will fall.

Equity Income Funds – the income comes from dividends paid to shareholders. In return for some risk to your capital, you may get a more regular income than you would from cash, and that income, as well as your capital, may increase over time.

Property Funds – pay income from rents, but the value of your investment can fall as well as rise.

There are also mixed asset funds, which invest your money in both bonds and equities.

Generating income

Interest from cash or money market funds
The income varies in line with the interest rate set by the Bank of England. The fund’s investment manager will aim to get the best rate available, helped by that fact that, with large sums to deposit, funds can often get better rates than individual investors. The capital amount you originally invested is unlikely to go down (subject to the limits for each deposit under the Financial Services Compensation Scheme). If the interest rate is lower than the rate of inflation, however, the real spending value of your investment is likely to fall.

Fixed interest from bonds
Bonds are issued by governments (known as ‘gilts’ in the UK) and companies (‘corporate bonds’) to investors as a way to borrow money for a set period of time (perhaps 5 or 10 years). During that time, the borrower pays investors a fixed interest income (also known as a ‘coupon’) each year, and agrees to pay back the capital amount originally invested at an agreed future date (the ‘redemption date’). If you sell before that date, you will get the market price, which may be more or less than your original investment.

Many factors can affect the market price of bonds. The biggest fear is that the issuer/borrower will not be able to pay its lenders the interest and ultimately be unable to pay back the loan. Every bond is given a credit rating. This gives investors an indication of how likely the borrower is to pay the interest and to repay the loan. Typically, the lower the credit rating, the higher the income investors can expect to receive in return for the additional risk.

A more general concern is inflation, which will erode the real value of the interest paid by bonds. Falling inflation, often associated with falling bank interest rates, is therefore typically good news for bond investors. Typically, bond prices rise if interest rates are expected to fall, and fall if interest rates go up.

If you invest in bonds via a fund, your income is likely to be steady, but it will not be fixed, as is the case in a single bond. This is because the mix of bonds held in the fund varies as bonds mature and new opportunities arise.

Dividends from shares and equity income funds
Many companies distribute part of their profits each year to their shareholders in the form of dividends. Companies usually seek to keep their dividend distributions at a similar level to the previous year, or increase them if profit levels are high enough to warrant it.

Rental income from property and property funds
Some people invest in ‘buy-to-let’ properties in order to seek rental income and potential increase in property values. Property funds typically invest in commercial properties for the same reasons, but there are risks attached. For example, the underlying properties might be difficult to let and rental yields could fall. This could affect both the income you get and the capital value.

Balance your need for a regular income with the risks
The income from a fund may be higher and more stable than the interest you get from cash deposited in a bank or building society savings account, but it can still go up and down. There may be some risk to the capital value of your investment, but if a regular income is important to you and you do not need to cash in your investment for now, you may be prepared to take this risk.

Income funds of the same type are grouped in sectors
The main sectors for income investors are: Money Market, Fixed Income (including UK Gilts, UK index-linked Gilts, Corporate Bond, Strategic Bond, Global Bond and High Yield), Equity Income, Mixed Asset (i.e. UK Equity and Bond), and Property.

Look at the fund yield
The fund yield allows you to assess how much income you may expect to get from a fund in one year. In the simplest form, it is the annual income as a percentage of the sum invested. Yields on bond funds can also be used to indicate the risks to your capital.

Decide how frequently you wish to receive your income
All income funds must pay income at least annually, but some will pay income distributions twice a year, quarterly or monthly, so you can invest in a fund which has a distribution policy to suit your income needs.

Select income units/shares if you need cash regularly
The income generated in a fund is paid out in cash to investors who own income units. If you choose the alternative – accumulation units/shares – your share of the income will automatically be reinvested back into the fund.