You are reading this because you are probably facing an investment issue, and want the best result and outcome to help you to live a better life.
We believe that if you follow our six factors, the chances of you having much better outcomes will be greatly improved, which is what you want after all. The aim is to enhance the likelihood of good results and also to minimise the risk of something going wrong for you. This is done in an environment of openness and trust, where investing costs and the impacts of taxation on your money are kept to a minimum, meaning that you keep more wealth.
What follows is a brief summary of these six factors and if you then want further information, simply contact us.
Starting off the investing process by believing that the entire aim of the game is to have a larger sum of money at the end than you started off with is a common approach. This might lead to you believing that you need a certain amount of money by a future date, your retirement perhaps.
Money, of itself, is rarely the true objective of investing. What you are truly seeking is the future lifestyle that a certain amount of wealth will provide for, with a comfortable margin for error. The ideal outcome. You are now prepared to invest money today rather than spend it, in return for a better future ahead of you.
A good starting point for you will be to identify exactly what your hopes and dreams are for your future and to also identify those fears or dreads that you very much want to avoid. This isn’t always easy for you to do, however, it is what we do for a living and we are expert at doing it well.
In finance, an investment is a monetary asset purchased by you with the idea that the asset will provide income in the future or appreciates in value and is sold at a higher price. So there you have it, the two key elements; Growth and Income. Growth to provide results for you that exceed the rate of inflation over time, so that your money keeps its ‘buying power’, and income to maintain your personal standard of living throughout your life.
If it were that easy, you would be a specialist DIY financial planning expert by now, but you’re probably not. With an adult population in the UK of some 50 million, there are only about 4,000 Chartered Financial Planners (the experts) to go around. That’s a ratio of 12,500/1. Even then you have to find a financial planner that you like and can work with, who understands and appreciates you, and who charges the sort of fees that work for you. Think how long that could take. Well, you have made a promising start because you have got this far; the proverbial needle in the haystack. Capital is a Chartered firm and all of our advisers are Chartered Financial Planners.
You may have realised that money or investing is really about emotion and how you feel, as opposed to just numbers on a balance sheet. At some point in your life, you may have experienced the joy and excitement of booking an exotic holiday, buying your dream car, moving into a lovely new home, selecting the best school for your children, or even fully repaying the mortgage. There is a flip side to this coin of course; the pangs of regret over those decisions that didn’t go so well. Interestingly enough, these feelings of regret can last a lifetime. So they are best avoided.
At Capital, we hold certain beliefs to be self-evident and true, which are supported by documented evidence and are the foundation stones of our robust approach. Not a confusing assortment, just six. If you follow these six guiding principles then you will really begin to stack the odds firmly in your favour and have a much higher chance of avoiding those regretful decisions and making the most of the positive outcomes that you are seeking.
1. Capitalism works to your advantage
In a capitalist economy, where assets are mainly owned by individuals and companies rather than the state, capital and labour are generally put to efficient use, seeking to generate the maximum return for those who take on the risk of enterprise. People like you.
Owners of capital have two choices: the first is to become an owner of companies through the purchase of shares; the second is to lend money to borrowers, either government (gilts) or companies (bonds). The risk of ownership is higher than the risk of lending and therefore the returns of ownership are expected to be higher than those of lending. Long-term market data shows that the rewards of ownership of company shares are higher than those of gilt and bond investors. And let’s be quite clear here, we are talking about companies in the UK you know well such as Shell, BP, Marks & Spencer, AstraZeneca, BAT, BT and the like, as well as the major companies throughout the world.
The conclusion that can be drawn is that capitalism, whilst not a perfect system, does a good job of apportioning capital effectively based on the risks involved, and should reward those who participate in the system. There is no need for you to create your own new alternative ‘ism’; just go with the flow.
Investors like you are well served by allowing the capitalist system to do the ‘heavy lifting’ in terms of generating investment returns. Participating in, and gaining the rewards of doing so, sits at the heart of our investment process at Capital.
2. Investment markets are efficient
Free markets price financial assets, like company shares, reasonably efficiently based on supply and demand (buyers and sellers). On the understanding that markets are efficient, then the price of a company’s shares reflects all of the information known about that company and that it represents the best estimate of the price of the share. The daily flow of new information to the market will be reflected in the share price. As new information is random, the movement of share prices could be regarded as a ‘random walk’. Mispricing of companies is likely to be rare, short-lived, and often unexploitable. As such, beating the market return is a challenging proposition even for the so-called ‘experts’ so why even attempt to out-muscle them all?
The documented evidence during the 2008/2009-market turmoil period clearly points to the fact that practitioners of market inefficiency (active managers) failed to take advantage of any inefficiency that existed.
To test this in a fun but scientific way, there is the ‘guess the jelly beans in the jar’ puzzle. Almost impossible to get it right, but ask enough people and then take the average of the guesses, and in the latest example undertaken by Dimensional Fund Advisers2 the average guess of 2,716 beans was very close to the actual number, 2,650. So if enough people participate in the market pricing of a company share, then the average should be about right.
The debate about how efficient markets are is less important than whether or not professional investment managers seem capable of beating the market in a consistent, long-term, and identifiable way. It is not unreasonable to make the assumption that markets work pretty efficiently, evidenced by the broad inability of professional managers to beat the market over longer periods of time. At the very least, inefficiencies that may exist do not seem to be exploitable, after costs, in any persistent manner.
In the context of our best interest rule we are obliged to weigh the evidence as to whether attempts to beat the market (either through timing markets or security/fund selection) provide you with the greatest chance of success or whether alternative strategies such as an intelligent approach – seeking to capture market returns – are in your best interests.
At Capital, we have an open mind and are guided by academic research, which so far indicates that professional fund managers who adopt the active approach (timing market movements and picking company shares) appear to be unable to beat the markets in a consistent, long-term, and identifiable manner. As a result, we adopt an intelligent approach to investing that aims to deliver market returns for taking specific risks. We will continuously review the research and will refine our position, where necessary, in the face of new evidence.
3. Reward and risk go hand in hand
It is a fundamental assumption that a company’s cost of capital defines the rate of return that is expected by investors for ownership in or lending to it. Otherwise capital would simply flow to companies with higher expected returns but lower risk. Simple and obvious.
You need to be asking yourself, and testing the outcomes of: what risks am I really prepared to take with my money; what risks do I really need to put my money under in order for me to achieve my future goal of a sustainable lifestyle; how much am I actually prepared to lose if things go wrong; what will I do if such a bad event happens to me; and as importantly, what is the risk of being too cautious and never achieving any of my chosen future goals?
Imagine that you were offered the following scenario. Would you accept it, yes or no?
You have a treasured amount of money that you need to invest carefully in order to ensure that the later stage of your life is comfortable, safe and secure, to allow you and your family to live very well and maintain your high standard of living.
A stranger, who you have never met before, promises to make you more money than any other professional fund manager. They ask you to give them your blind and unadulterated trust. Once you give them every last penny of your money, they then fly first class to Las Vegas and stay in a leading exclusive resort hotel, all paid for by you.
They then start to gamble your money in the casinos, on roulette, craps, blackjack tables, and the like. Some they win, some they lose, some come out even. Before they start gambling, they take a percentage of the stack to keep for themselves, for the privilege of being in Vegas on your behalf. Every time a gamble is made more is taken from the stack, both by them and the casino. When they win big, they take a share of the win for themselves. When they lose big, they still keep their share of the stack. When they lose, this doesn’t impact their fun, lifestyle, or financial reward. It simply means they come back with less of your money, having had a great time at your expense.
During the entire period, you have little idea of what they are doing, and little or no control over how they do it. Every so often and in many cases a year later, they catch up with you and regale you with tales of what they have been up to, how clever they have been, how badly the other guys did, and how lucky you are to be where you are: up a bit, down a bit, or about where you started.
So would you accept this deal, or not?
You want to really align the outcomes you desire at a future date, with the given acceptable level of risk you are prepared to take to achieve them, then you need our professional help.
Given the assumption that markets work reasonably well, for you to achieve a higher level of return, you inescapably have to take on a higher level of risk. Less experienced investors commonly seek higher returns with low risk. In investing, such outcomes rarely exist and often result in overpaying for insurance, combined with gambling. If something looks too good to be true, it usually is.
If it is accepted that markets work and risk and reward go hand in hand, then identifying, understanding and selecting (or rejecting) different investment risks becomes the focus of logical and common sense portfolio construction. If you need little or no investment risk to meet all of your future hopes and dreams, then why would you place your money in harm’s way?
4. Don’t put all of your eggs in one basket
The concept of not putting all of your eggs in one basket is probably intuitive to you. One trip or stumble and all is lost. You don’t want that, especially as some trip hazards are hidden from view and are unexpected.
So how many baskets do you need (we call the baskets asset classes)? There are four to choose from: cash, gilts and bonds, commercial property and company shares. Well, you need cash for sure. Bank deposits and perhaps some NS&I holdings. Readily available to you at short notice. Just enough so that you feel comfortable with the level of your savings bank balance. Only you can decide what that number is.
As mentioned in article 1, lending to the government (the treasury) in the form of buying gilts, or to companies (like M&S) in the form of a corporate bond is seen as an important part of an investment portfolio. This is often viewed as the ‘defensive’ element of the mix.
Then comes the commercial property category – business parks, distribution centres, shops, and offices. Over long periods of time, these have proven to be resolute elements of the mix.
The fourth element is company shares, both in the UK and globally. These are viewed as the ‘growth’ engine of the mix because long-term records show that holdings beat the returns on cash, inflation and gilts and bonds. Obviously, there have been periods when cash comes out on top, or when gilts forge ahead of company shares.
Achieving the correct mix appropriate for you is both the art and science of what we do with you. We call this diversification. Having the correct mix should mean that as one element is falling in value for some reason, others are holding their ground or are growing in value. It is unusual for all four categories to rise or fall in unison at the same time, but it can happen.
Diversification across the four classes by owning a wide basket of holdings that behave like the market (and market risk factors) makes sense. The use of collective investment vehicles such as unit trusts is central to the process. Diversification away from company shares asset classes alone also makes sense to avoid long and short-term return disappointment.
Seeking ways to reduce market risk for you, across a wide range of market environments and over time is central to our robust portfolio construction. Portfolios make use of diversification opportunities at the asset class and security levels, wherever possible, to minimise risk and ensure that market returns – the return of capitalism – is captured.
5. Costs matter so ignore them at your peril
Whichever firm you approach to invest your money, you may well want to know – how much will it cost to invest money with you? No doubt you will be given an answer to this, which satisfies your request. The real issue is – do you know the right questions to ask, in order to get the complete response, with nothing missing? In our opinion, we do not believe that investors are equipped to ask all of the detailed questions of professional investment managers and as a result, are only told part of the answer. We don’t think that is right or fair. So we tell you the whole truth about the cost of investing.
Any equal sum of money invested over an identical period of time and at the same rate of return can only result in different outcomes based on two factors: Taxation and the drag effect of costs and charges. Both of these factors are known and real and can be controlled to an extent. An example will clearly show the impact of poor choices.
Imagine investing a lump sum of £1 million for 20 years where the cost-free rate of return is 7% a year. Imagine again that there are then three further options open to you:
Investment 1 carries a cost of 1.0% a year.
Investment 2 carries a cost of 2.5% a year.
Investment 3 carries a cost of 3.5% a year.
The problem is that you don’t know what these costs are when you invest your £1,000,000. They are withheld from public view.
At the end of the 20 years this is what you would get:
Investment 1 £3,207,134
Investment 2 £2,411,712
Investment 3 £1,989,787
Option 1 gives you £795,000 more than option 2 and £1,217,000 more than option 3. This is how much of your money you don’t get to keep. Think about that when anyone tells you that charges, fees, and tax don’t matter. They really do a lot. To put this into perspective, the investment manager model 3 has consumed more in costs than the original amount you invested. Those ‘small’ percentages soon add up. Which outcome would you prefer? Well, 1 of course. So it does pay you to do research and only work with those firms, like Capital, who disclose costs and aim to keep them as low as possible.
There is a huge third element which will impact your future values, and that is the year-on-year return (or loss) you earn on your investment. Unlike the two elements (tax and costs), which can be controlled to your advantage, future performance levels of your money can only be guesswork. As the warning from the regulator clearly states: Past performance is not indicative of future performance. They mean what they say. This is not an idle statement to brush under the carpet of inconvenience.
The vast majority of investment managers in the UK (financial advisers, banks, discretionary fund managers, wealth managers, stockbrokers and the like) all generally claim to be able to ‘beat the market’ and to produce market outperformance for you. In effect, their gain is somebody else’s loss. The trouble is, they all think they are the winners and not the losers, but that isn’t how the markets actually work.
Which brings us back to evidence and facts. There is a huge body of research that evidences that the markets can’t be beaten over time on a consistent basis by any single investment management firm. In fact, after their costs and charges are taken into account, the vast majority don’t even match the performance of the markets they invest in over long periods.
Investors frequently focus on headline investment returns that the markets deliver (such as comments about the FTSE100 index on the news), and fail to take into account the severe deductions from the long-term wealth of the costs they suffer. These include the effects of inflation on purchasing power; the cost of tax; and the significant ‘all-in’ cost of investing (e.g. fund manager ongoing charges and turnover costs).
Reducing costs is one of the few free lunches in investing. A pound of costs saved is no different to a pound of market performance in monetary terms, yet it is far more valuable due to its consistency over time and the fact that it is achieved without taking any risk. Minimising costs in your investment programme can have significant benefits over time, through the effects of compounding.
Money saved by you through reduced investment charges is a real and current benefit. Many costs are hidden, complex, or difficult to measure. You may question why this is. Never rush into making a lifetime investment until you are certain that you have understood all of the implications and costs involved. Finding out later may be too late. At Capital, we believe in honesty and clarity and we explain all investment costs in pounds and pence before you make any decisions.
6. Taxation can have a significant impact
If you are like most people, completing your self-assessment tax return each year can be a daunting task. That’s why most people pay an accountant to do it. Tax can be confusing and complex, and getting the numbers wrong can have implications.
Taxation isn’t taught at school, but perhaps it should be. Give yourself a minute or two to think about your own tax affairs: what rates of income tax do you pay and on which bands of income? And your employee rates of National Insurance (or self-employed of course), and on which income bands? How are the dividends on your shares taxed? At what level of income does child allowance reduce to nil and when could you lose your own personal allowance? You sell an asset you have had for 28 years at a large profit, so what rate of capital gains tax will you pay?
Don’t worry; the pass rate for self-test questions is pretty low. When it comes to the taxation of assets that you own, this is a different world altogether. Within your investment portfolio, you may own company shares, government gilts, investment trusts, unit trusts, REITS, pension funds and OEICS, plus a host of other structures too many to name. How are these investments taxed internally? What are the implications of the different taxes on the outcomes that you are aiming for?
To make matters even more confusing, much will depend on the tax ‘wrapper’ that you are investing within, be it a self-invested pension plan, an employer defined benefit pension scheme, an ISA or even a discretionary fund manager portfolio.
Your personal taxation, the investment taxation and the ultimate ‘wrapper’ taxation will all have an impact on how much you get to keep. It makes sense to have experts on your team who can tell the difference.
While it is acknowledged that the tax tail should not wag the investment dog, sensible portfolio management, and the legal and standard use of allowances and tax shelters, such as ISAs and pensions, and in specific and appropriate circumstances other investments, can make a significant impact on the likelihood of a successful investment outcome, in line with your goals.
From a portfolio investment perspective, it makes sense to avoid turnover (the buying and selling of your assets) in a taxable environment that triggers capital gains. The use of collective investments like unit trusts helps to provide some shelter from capital gains tax for transactions undertaken within them. Turnover between collectives, due to rebalancing or fund replacement, should be made with reference to the tax implications. The use of portfolio cash flow can also be used to mitigate the tax costs of portfolio turnover. The efficient use of tax structures, allowances, and other legal tax efficiencies are discussed on an individual client basis as part of our advice process.
Don’t ignore taxation. It may not be obvious, but it is there and it can erode your investment returns. There is absolutely no point in you taking greater investment risks to try and achieve improved market returns only to see the net gain destroyed by unexpected taxation. Many investment managers won’t discuss taxation with you because it is also confusing and complex for them to explain, as well as being a distraction to you.
Investing successfully over a lifetime isn’t easy. In fact, it is very difficult. The Finance sector in the UK is valued at £6.6 trillion, which is an awful lot of money. And investors like you face a confusing array of choice matched with complex investment structures. This isn’t the place for the DIY amateur.
Some critics say that investing is like a Casino where the house always wins, in effect a form of gambling. There are a few lucky winners, but most people lose. This assumption, actually, is completely wrong because those who hold assets for the longer-term, for example, a stake in several companies, tend to do particularly well.
Others want to believe they have discovered ‘the next big thing’, but in effect, this is simply speculation.
While it is often confused with gambling, the key difference is that speculation is generally tantamount to taking a calculated risk (and the potential total loss of your money) and is not dependent on pure chance, whereas gambling depends on totally random outcomes or chance.
Neither of these two alternatives, gambling and speculation, are the foundations for your financial future to be built upon.
If you choose Capital to invest your hard earned money we promise to do three things for you:
- To keep costs down to as low as possible, leaving more money on the table for you
- To invest your money in a tax-efficient manner and so reduce the amount lost in taxation
- Build an investment portfolio to produce future returns targeted to beat inflation, so keeping your purchasing power intact
Your investments can go down as well as up.
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