YOU HAVE £250,000 TO INVEST. HERE'S HOW TO GET RICHER
Investors are living in a new world. Eighteen months ago the old order of ultra-low interest rates came crashing down and today’s markets are unrecognisable from the past decade.
Old rules have been torn up and the portfolios of the wealthy are being hurriedly rearranged to reflect rising savings rates, sluggish stock markets and a crackdown on property investing.
So, where is the best place to invest £250,000 in 2023? Our experts worked out what return you could get on each asset over the next five years.
The dash to cash
Cash accounts have been an unattractive home for money, offering next-to-nothing returns thanks to ultra-low interest rates – until recently.
Now that the Bank of England has raised the official Bank Rate 12 times from an all-time low of 0.1pc in December 2021 to 4.5pc now, there is a logical argument for savings accounts to be making a comeback for longer term money.
Some accounts are paying almost 5pc on savings. Close Brothers Savings is paying 4.96pc on a one-year fixed-rate bond.
One-year fixed rate bond
Isbank Raisin UK pays 4.95pc on its five-year account, while the highest rate on an easy access account is 3.71pc from Chip, according to the data firm Moneyfacts.
Depositing the full £250,000 in a five-year fixed rate at 4.96pc would result in an accumulated value of £320,201 after five years.
Using a variable rate account – where you can access your money at any time and not forfeit any interest – could be a mistake should rates start to fall.
And while a 5pc return is attractive it’s important to factor in the corrosive power of inflation that means that the spending power of your money is eroded over time.
Inflation remains in double digits though is expected to fall this year, so even if your money is in the top paying rates it is losing value in real terms.
Jason Hollands at wealth manager Evelyn highlights that the UK rate-hiking cycle is now in its late stages.
He said: “Once there are signs that inflation is in rapid retreat, interest rates may well have to follow suit within a few months to avert a recession.
“Although UK inflation has remained painfully high in recent months, while edging down, I would expect it to decelerate more rapidly over the coming months as the sharp surge in energy prices seen when Russia began its invasion of Ukraine last year drops out of the 12-month figures.
Cash is a handy resource should you want to move fast on a buying opportunity. However, advisers typically warn that holding it for too long means missing out on gains you could have been earning on other assets.
How tax works on savings
With £250,000 on deposit, there would be tax to consider too. Basic-rate taxpayers will pay tax on any interest over £1,000 earned from an ordinary savings account. Higher-rate payers pay tax on interest over £500 while additional-rate payers get no tax-free allowance (use our calculator below to see how much tax you might have to pay).
You could also use the annual £20,000 Isa allowance if you haven’t used it already.
Now Read: How to invest like the best (and the strategies to avoid)
Re-invest dividends – and beat cash
Investing in the stock market is the go-to for financial advisers who would advocate that long-term money is best placed in a “balanced” portfolio for stocks and bonds.
Crucially, investing in the stock market offers the chance for both capital and dividend growth – a useful tool for fighting inflation over time.
Mr Hollands said: “While today’s higher savings rates might appear to make the case against investing in the stock market, which carries greater risk, it is really important to consider your time horizon.
“You won’t experience any capital growth alongside the interest received and so the real value of your cash is going to be chipped away by inflation over time.”
He added: “Unlike a savings account, investing in the equity market also has the potential to deliver both capital returns over the medium to longer term, and dividend payout rates also have the scope to grow too, once the economy turns a corner and company profits rise.”
Stock market investments are also expected to be boosted by a potential recovery in London listed companies. British stocks appear cheap at the moment, analysts say, with the FTSE 100 index of the largest listed companies trading at 10.5 times forecast earnings. This is a low figure compared to other developed stock markets around the world.
There are also attractive dividend yields – the index currently has a 12-month forward dividend yield of 4.2pc. That may not seem attractive when compared to the guaranteed return on savings, but what it doesn’t take into account is the “total return” of the market.
Analysis by Evelyn shows that if you assumed a, not unreasonable, compound annual growth rate of 6pc on equities (capital gains and dividends reinvested) then at the end of five years, £250,000 would be worth £337,212 – £18,901 more than the cash option above.
Mr Hollands added: “None of us have a crystal ball, it could be higher, or it could be lower. But this is not a wild assumption as over the last 20 years the annualised return on the FTSE 100 has been 7.3pc.”
Although stock markets can be volatile, they have the best track record of beating inflation. According to the Barclays Equity Gilt Study, equities have beaten the real return from cash in every decade since the 1920s, including periods of high interest rates.
If you're investing with the aim of growing your pot as much as possible, you can afford plenty of ups and downs along the way, provided you reach your goal in the end.
Big drops in value, however, could be very damaging to an income investor. If you take money out of a falling fund you run the risk of eating into capital and it then becomes much harder to recover the losses.
How tax works on investments
If you haven’t used up your Isa allowance, there’s £20,000 a year worth of tax-free investing. In a general investment account, however, you will pay capital gains tax after the annual tax-free allowance of £6,000 is exceeded (£3,000 from April 2024), income tax on any interest earned plus dividend taxes once you pass the tax-free allowance of £1,000 (£500 from April 2024).
Now Read: How you can become an Isa millionaire – and how fast
Bricks and mortar for 6.5 per cent
If you already have a healthy pension, Isa and investment portfolio you might decide to choose a different asset class to diversify.
Property offers the potential for capital growth as well as a rental income.
With house prices remaining high the entry point is challenging, and the trimming of tax breaks means landlord’s profits are being squeezed.
Yet there is money to be made. According to estate agent Hamptons, on a £250,000 property bought for cash (no mortgage) and assuming 5pc annual rental growth, an investor could expect total income after costs of £71,700 after five years. Average rental yields this year are forecast to be 6.5pc, said Hamptons.
David Fell, senior analyst at Hamptons, said: “Looking forward, it’s likely that rental income is going to account for a larger chunk of investors’ returns, as higher interest rates bear down on house price growth in the medium term while fuelling rental growth.
“Yields have risen across the country. This is a product of rents going up while house prices have remained flat, which reflects increased costs for most landlords. While rents, as opposed to price growth, have historically always tended to generate the bulk of returns in northern England, we expect returns in the south of the country to take a fairly similar shape over the next five or so years.”
The income from property can be taken if needed, or it can be re-invested. Some landlords choose to build up a cash pile to fund their next property purchase if they want to add to their portfolio. Others reinvest in other ways.
Venture capital trusts (VCTs) are a popular option, as they allow rental income to be invested tax efficiently. VCTs are funds that invest in a basket of typically 50 to 80 privately owned companies that are often hard to access on listed markets.
These range from tech businesses to consumer brands including fashion retailer ME & EM, jeweller Monica Vinader and burger chain Five Guys. To compensate for the extra risk of investing in these companies, you can offset 30pc of your investment against income tax liabilities as well as receiving tax-free dividends.
To qualify for the tax break you must hold the investment for at least five years.
There are risks involved with property ownership to weigh up, of course. There could be further tax changes, periods where the property is empty, or a sharp house price correction impacting capital growth. Buying with a mortgage will severely dent profits and, as rates have risen dramatically in recent months, requires a much larger deposit than in the past.
How tax works on rental properties
Income from rental properties must be declared and will be charged at your marginal rate. The first £1,000 of your income from property rental is tax-free, known as the property allowance. You can also deduct certain costs such as accountant fees, maintenance and repairs to the property (but not improvements) and ground rent or service charges to bring down your tax bill.
Now Read: The five key rules that every buy-to-let landlord must know
The Verdict
The stock market comes out on top – turning £250,000 into £337,212. Despite rates at their highest in more than a decade, money left in the best savings account only becomes £320,201 after five years.
After costs, a rental property could bag you income of £71,700 – equivalent to £321,700 if you include the cost of the property. With a fair wind, you would expect the property’s value to have grown over five years – though many economists are forecasting price falls for later this year. Cash tied up in a home is nowhere near as “liquid” as cash and shares. It can take months or even years to get your money back.
Most people should have a mixture of asset types, blended depending on your access to ready cash for emergencies and guaranteed income.
2023-05-25T05:02:52Z dg43tfdfdgfd