Stock market investing is unlikely to rank top of most 16-year-olds' lists of favourite hobbies but the early bird catches the worm, so it could be well worth kicking things off early like one of our young readers aged 16. Jake has already been investing for a year and has built up a portfolio of funds within his Junior individual savings account (Isa) and self-invested personal pension (Sipp), and now wants to know how he can improve on his asset allocation and portfolio strategy to build up a healthy retirement pot.
Sipp, Isa or both?
When investing the first step is to decide what wrappers to hold your investments in. You or your child might know which investments you want to the money into but remember that at 16 or younger the level of control you have over your investments and the age you can access them differs depending on the account.
Tax-efficient wrappers such as Isas and Sipps are the best ways to hold investments as they grow free of tax, and with a Sipp you get 20 per cent basic tax relief on contributions. You can take control of the investment decisions for an Isa at age 16 but not access the holdings until 18. With a Sipp however, your parents are in charge of the investments until you reach 18 and you won't be able to access the money until you reach retirement age, which, by the time Jake does, could be 58 or older.
Lauren Peters, chartered financial planner at Helm Godfrey, says: "For young investors it's worth being aware that the minimum age for accessing pensions will be 57 from 2028 and is likely to rise again by the time today's 16-year-olds get into their 50s."
That is great news for the investments in your pot, which will have had at least 50 years to grow, but it might not be great news if you need some of your money before then to pay for university fees or buy a house. "I would be cautious about using a Sipp at age 16," says Martin Bamford, chartered financial planner at Informed Choice. "From a purely mathematical view it looks good due to the tax relief and the power of compounding, which will make Jake's investment worth a lot by the time he reaches age 60. But I think it makes sense to have access to the money when he is so young."
So Mr Bamford recommends holding all the money in a Junior Isa.
James Norrington, specialist writer at Investors Chronicle, agrees. "I would question why Jake has a Sipp when he has plenty of Junior Isa allowance left (£4,080 for the 2016-17 tax year)," he says. "The current lifetime limit for pension savings is £1m and who knows if future chancellors will reduce this? Jake is starting investing young so should plan how he is going to use the lifetime of tax benefits available to him. As he moves into employment, he'll want to take advantage of the maximum annual tax benefits available to pension savers and also any contribution-matching schemes offered by employers. Therefore it doesn't make sense to use up pension lifetime allowance now when you he has other tax wrappers available to him."
There are other disadvantages to opting for a Sipp with a portfolio of this size. Sipps are most suited to investors who want maximum flexibility with investments and have fairly large pots, because as well as offering greater choice they have relatively high annual charges. This means Sipps are less cost-effective for smaller sums.
"Jake doesn't necessarily need to have a Sipp," says Patrick Connolly, chartered financial planner at Chase de Vere. "He has a very small amount in quite a small number of funds. He might be paying more in charges than he needs to and a personal pension, for example from a company like Aviva, might be a better route. A Sipp is quite an expensive option for the amount he is holding."
Sipps versus Isas
|Feature||Junior Sipp||Junior stocks and shares Isa|
|Age of control over investments||18||16|
|Access to savings||Currently 55, set to increase||18|
|Maximum investible amount per year||£3,600||£4,080|
|Tax benefits||20% up-front tax relief on contributions||Tax-free income|
Source: Investors Chronicle
It's worth making the most of any give-away the government gives you. When you turn 16 you can open a normal cash Isa or a Help-to-Buy Isa as well as a Junior Isa. And at age 18 you will be able to open a Lifetime Isa from April this year. You will also be able to roll a Help to Buy Isa into a Lifetime Isa.
When Jake turns 18 he'll be eligible for a Lifetime Isa, and the government will pay in an amount worth 25 per cent of his savings up to £4,000 (a maximum government contribution of £1,000 each year) between the ages of 18 and 50. "This could be worth up to £32,000 of free money in Jake's lifetime and overall, the higher limit of £20,000 (from April 2017) gives investors the opportunity to accumulate significant tax-free savings outside their pension allowances," says Mr Norrington.
How to build a portfolio from scratch
For a 16-year old starting a portfolio Colin Low, managing director of Kingsfleet Wealth, recommends allocating 75 per cent to global equities and 25 per cent to UK equities. He says with an amount of money similar to Jake's of around £5000, allocating £500 to each fund sounds reasonable, as if he has less than that in any one holding its impact will be diluted too far. He recommends prioritising global equities first, then UK equities before diversifying into areas like emerging markets.
Mr Connolly adds: "The number of holdings Jake has is fine for his size of portfolio, although I would leave it at that level for a while. Portfolios become unwieldy if they have too many different funds with small amounts in them."
If you are starting with around £1000 or less, Mr Low says a good way to build up a portfolio is with two passive funds - a global equities and UK equities fund. For global equities options include iShares Core MSCI World UCITS ETF (IWDA) and Vanguard FTSE All-World UCITS ETF (VWRD), and to track the FTSE 100 you could add iShares Core FTSE 100 UCITS ETF (ISF) or db x-trackers FTSE 100 UCITS ETF (XDUK).
Investors with smaller pots should use investment platforms that charge percentage-based annual fees rather than flat fees. Flat fees are good for those with large pots, but do not make sense when the amount is a high proportion of your total.
Another good tactic is to drip feed the same amount of money into your pot regularly to benefit from pound-cost averaging, whereby you buy fewer units when prices are high and more when they are cheap.
Jake wants to build up retirement savings by generate a 7 per cent annual return. He wants to know if he should be investing in higher risk investments such as Asia and emerging markets funds to generate better returns. He is considering investing in tech-flavoured global equity fund
"My age gives me a considerable head start which will allow my investments to compound in value over many years," says Jake. "My investment philosophy is to stay away from individual shares for the most part although I do own some shares in
"Because I'm so young I can afford to ride out all the ups and downs of the market, so I am open to a fair amount of risk. But I'm not prepared to lose more than 30 per cent in a given year."
Chris Dillow, Investors Chronicle's economist, says: "An expectation of 7 per cent annualised real returns is too high. According to Credit Suisse, UK equities have returned 5.4 per cent a year since 1990. There is no good reason to suppose future returns will be higher than that and several reasons to expect lower."
But Mr Low says: "7 per cent a year is a punchy aim and not achievable in the current economic climate, but could be in the future."
And Mr Bamford adds: "Over 50-plus years maybe, but in the current environment this is unrealistic."
Starting investing at 16 means you have a very long investment horizon, so you can afford to take a high level of risk to generate above-average returns. This is particularly the case with Jake's Sipp, which he won't be able to access for over 40 years.
Mr Norrington says: "There is a high allocation to UK shares in Jake's Sipp split across several fund holdings. As Jake is just starting out it isn't a problem to have a bias to his home market, but he should build towards a globally diverse asset allocation strategy. He should also try to keep the number of funds that he uses for each region and asset class manageable, and be agnostic in terms of whether he chooses passive or actively managed funds.
"If Jake wants total return exposure to a region or theme then he could use a passive strategy, which is often cheaper. However when investing in some themes, for example tech stocks or complex markets such as India, he may benefit from the specialist knowledge of an active stock-picking manager. However, the impact of expenses accumulates over time so he should keep an eye on whether he is getting the most cost-effective performance from his funds."
Mr Dillow says emerging markets are a good idea as a diversifier but adds: "The idea that emerging markets will do well because their countries offer faster economic growth is wrong. There has been little correlation between longer-term sterling growth and equity returns. The case for emerging markets is that they diversify the risk that secular stagnation will continue in the west with adverse effects upon Western equities."
Mr Dillow also suggests adding some allocation to a high growth and higher risk area like private equity. "One omission from this portfolio is private equity which you can access via several investment trusts," he says. "It's possible that long-term growth is more likely to come from unquoted rather than quoted stocks. A private equity fund gives you access to this. This merit, however, is mitigated by the fact that individual funds' returns are very variable."
Mr Dillow also approves of Jake's interest in Scottish Mortgage Investment Trust. "This has a decent high-conviction manager," he explains. "Its merit is that some of its holdings have what Warren Buffett calls moats - entrenched market power that allow a company to fight off competition. Holdings such as
Jake's Isa is more concentrated than his Sipp.
"Despite the fact he will likely need it before his Sipp, he is taking more risk," says Ms Peters. "My concern is that there is a lot of risk here and not much downside protection. He's over-exposed to Asian markets and has a lot invested in CF Woodford Equity Income, comparatively.
"There is also a lot of exposure to Asian markets and most of the stock is income paying rather than growth oriented. He could consider some growth stocks, given the time scale for investing. Imperial Brands is an individual share, rather than a fund, so is likely to be pretty volatile."
|Jake's portfolio||Value (£)||% of portfolio|
|CF Woodford Equity Income (GB00BLRZQC88)||475.74||9.00|
|Imperial Brands (IMB)||237.69||4.50|
|Jupiter India (GB00BD08NQ14)||280.43||5.31|
|Stewart Investors Asia Pacific Leaders (GB0033874768)||283.4||5.36|
|CF Lindsell Train UK Equity (GB00BJFLM156)||782.1||14.80|
|CF Woodford Equity Income (GB00BLRZQC88)||987.34||18.68|
|MI Chelverton UK Equity Income (GB00B1Y9J570)||626.87||11.86|
|db x-trackers FTSE 100 UCITS ETF (XDUK)||549.2||10.39|
|Lindsell Train Global Equity (IE00BJSPMJ28)||1,061.89||20.09|
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