Savvy investors know that if you want to increase your wealth, you have to make every penny work harder.However, when faced with a lump sum to
invest, there are a huge range of choices available. One big challenge for investors in the current economic environment is finding a way of generating good returns without taking too much risk with their money.
So here is a step by step guide to making the most of your investment so that you can make the best decision tailored to your personal financial circumstances and objectives.
Step One: Do you have debt?
It’s best to tackle outstanding debt, as you will usually pay more interest on debt than you will earn on savings. For example, the money information site Moneyfacts.co.uk shows that best buy personal loans rates start at around 4%, while the best interest rates paid on two year fixed rate bonds are only around 2% and variable rates on cash deposit accounts range from 0.75% to 1.40%.
Step two: what are your other investments?
It’s important to think about your portfolio as a whole. Do you have large holdings in cash, or do you have exposure to shares and equities? Do you hold bonds, properties, or alternative investments and in what proportion? The best way to grow your wealth is to have a diversified portfolio so that any poorly performing assets can be balanced out by others which do better. So, for example, if most of your holdings – including pensions and investments – are in shares, you might want to consider other asset classes such as bonds and property.
Step Three: What is your attitude to risk?
This is an important consideration which people often neglect to take into account. Cash is, of course, the least risky investment, but given that interest rates on cash are pitifully low, your money is effective being eroded in real terms because of the effects of inflation. Plus if you are a higher rate tax payer then holding most of your money in cash is not tax efficient. If you were constructing a “cautious” portfolio then typically it might be made up of assets including cash, bonds, commercial property and UK shares.
A more adventurous portfolio would probably have a greater percentage of equities and would include exposure to commodities and overseas equities and property. Generally speaking, the more adventurous your portfolio, the greater the potential return, but also the risk.
Step Four: What is your time frame?
If you are going to need your money within the next year to 18 months, then you don’t want to be taking much risk with it. However, if you have a three to five year time frame, then the range of options available increases considerably.
Step Five: What are you wanting to invest the money for – income, capital growth, or both?
Depending on your lifestyle and income requirements, you may be investing purely for capital growth, or you may need income alone, or a combination of the two. Do you need high levels of income, and are you prepared to risk the initial capital sum? For many people, it is important not to risk or erode the initial capital investment.
Step Six: What is your tax position?
If you are a higher rate taxpayer you will know that it is important to use tax-efficient savings and investment vehicles where you can in order to maximise your returns. These include Individual Savings Accounts into which you can invest £15,000, and making the most of your annual capital gains tax allowance, which for the 2014-15 tax year is £11,000 per person. If you are a high earner you will need to think carefully about what contributions you make into your pension, and whether you need to divert your money elsewhere, as you may breach the Pensions Lifetime Allowance and be subject to an extra tax charge.
Step Seven: What options do you have?
To construct a well-balanced portfolio you need a combination of property investments, equities, commodities, cash and bonds. The proportion of each asset class will depend on what risk you are willing to take, what return you are hoping to make, how old you are and what your investment time frame will be.
If you have a lump sum of £25,000, for example, you have a range of options depending on whether you are investing for growth or income.
If you already have holdings in cash, bonds and UK equities, then you could look further afield at overseas equities and property as an opportunity for diversification and potentially greater returns.
One way to do this is to buy US property as part of a group investment with other investors. That way, you have exposure to far more valuable properties that you would if you were buying individually. For example, a lump sum in the region of £36,000 is unlikely to be a large enough deposit to raise finance for a US property, and buying an individual property exposes you to a greater risk of voids and tenant problems as your risk is concentrated in a single apartment or house. However, buying a share of an accommodation block with other investors means you can spread your risk, you don’t need to leverage your investment, and your money starts working from day one.
When you are choosing where to invest your lump sum, think about how much income you would like to generate from it, and how much risk you wish to take. Opting for a pooled investment relieves you of much of the administrative headache and paperwork associated with individual property ownership.