It's January. Time for diets and resolutions - and time to spring clean your finances. With a year of regulatory change ahead, you should take the opportunity to ensure your long-term investments are working hard and suit your investment goals. We give our essential tips for a portfolio makeover.
1: Be tax smart - use your allowances:
Like going to the gym, this is one we all set out to do every year. But make a point of using your Isa limits in particular this year. Doing so can make a significant difference to your long-term financial well being.
A poll by Fidelity Investment Managers shows that more than half of people want to make their money work harder in 2011. However, just 11 per cent say they want to make the most of their tax allowances - meaning they will be throwing their hard-earned cash away and unnecessarily gifting the tax man.
Recent research shows that 42 per cent of people in the UK are missing out on tax breaks by not using their annual Individual Savings Account (Isa) allowance. Up to £10,200 can be saved in an Isa before the end of the current tax year on 5 April. What is more, investors could be up to £28,000 better off with the increased 2011/12 allowance, according to Fidelity. For example, if 35 year old basic-rate tax payer placed the new allowance of £10,680 into an Isa, assuming an annual return of 4.5 per cent each tax year before charges, they could amass £679,077 by the time they reach 65. This is an extra £28,803 than if the Isa allowance remained at its existing level of £10,200 a year.
2: Take another look at pensions:
If you don't have a pension, then think again, as this year there will be a game-changing moment in pensions. On 6th April 2011 the compulsory annuity purchase rules will be scrapped. Flexible drawdown will be introduced for those able to satisfy a £20,000 minimum income requirement, with capped drawdown available for all the rest. As Tom McPhail of Hargreaves Lansdown says: " To imagine that this rule change is of narrow relevance, affecting only those wealthy few who qualify for Flexible Drawdown is to miss the point; this rule change means that all pension investors will be able to commit long term savings to a pension, knowing that they will be able to retain control over that money right up to the day they die. It is a game-changing moment."
Pensions remain an extremely attractive shelter for long-term savings, so if you are able to contribute into a pension then you should consider doing so.
If you do have a pension then it's time for a pensions audit. The pensions landscape had a complete facelift in 2010. Review your retirement planning to take advantage of the new rules coming in.
3: Rebalance your portfolio:
More than one in ten investors (13 per cent) only review their core investment holdings once a year, according to a study by JP Morgan Asset Management. We don't want to encourage over-trading, but if you have made big gains or losses then it is time to see if your portfolio is still matching your plans. Gains in one area and losses in another could have substantial effects on your overall asset allocation.
4: Consolidate your investments:
If you haven't used a fund supermarket yet, then it is time to do this. Wrap up your old pensions in a Sipp. Cut down on paperwork. Make administration easier so you can concentrate on getting your investment strategy right.
5: Work out your attitude to risk:
Use asset allocation to control risk. Your mix of stocks, bonds and cash and the way you rebalance are the key determinants of both risk and return over the long term. But is your personal risk really the volatility of your investments? Or rather the risk of not meeting your financial goals, such as not having enough to fund your children's education or enough to retire on time?
Recent survey figures from One Poll show that 52 per cent of the UK population are saving for financial security, 30 per cent for a special occasion, 15 per cent are saving to provide for children/grandchildren, 14 per cent want to retire early and almost one in 10 want to pay a lump sum off their mortgage. Make sure you are clear about what you are saving for in the future and budget accordingly. And don't forget that your reasons for investing may change over time.
6: Take more risk - if you can afford to:
Over the past year almost a third of investors (32 per cent) admit to holding the core of their investment portfolio in cash according to a study of investor habits conducted by JP Morgan Asset Management's Investment Trusts. However, the low-interest environment will mean that these investors will have experienced at best low single digit returns on their cash and it is likely that the value of their investment could have gone down in real terms as a result of the impact of inflation (annual consumer price inflation in October 2010 was 3.2 per cent).
The volatility in equities over the past year may have put investors off. But 2011 might just be the year to turn things around. After what is often dubbed the "Santa rally", equities are tipped to be the asset class of 2011, while cash is expected to deliver paltry returns, and there is much talk of a bubble in bonds. So it could pay to take more risk and up your equity exposure.
Pay attention to your cash deposits. Savers had a tough year in 2010 with low interest rates and high inflation giving little return on their money. Switching from an easy account paying the average rate of 0.74 per cent to Northern Rock's easy-access account offering three per cent could generate an extra £226 of interest based on a savings pot of £10,000, according to Moneysupermarket.com.
8: Think more about your own investment behaviour than market predictions:
Did you have the means and discipline to buy stocks or funds in 2009, when stock prices were low? Did you stay invested during the volatility of 2010? Will you next time around?
9: Try an alternative – Wine, Timber, private equity, infrastructure, anyone?
Alternative investments survived the crunch relatively unscathed and can provide powerful diversification to your portfolio. Recent research also shows that asset management fees for most non-traditional asset classes have fallen following increased scrutiny from cost-conscious investors, according to a report by Mercer. In particular, fees for hedge funds, private equity, infrastructure and real estate have all decreased. Fees for traditional asset classes have varied, with some increases observed in long-only equity and fixed income strategies. Perhaps it’s time to broaden your investment horizon, and try some "alternatives".
10: Cut your costs:
Take a hard look at the charges on your investments. What does your stockbroker charge? What do your funds charge? Can you get them cheaper elsewhere? Even small differences add up to significant sums over time. It's quite appalling that charges are so high, particularly in the open-ended funds industry.
The quoted annual management charge (AMC) of a fund is only part of the story. Other expenses (legal, audit costs etc) can add another 0.4 per cent to this figure - this total is called the TER or total expense ratio of the fund. In an extreme case fund managers at TCF Investment found a fund with a TER that was six percentage points higher than the AMC.
But the TER does not include the trading costs of buying and selling the stocks inside a fund.
An equity fund with a 1.7 per cent pa TER and 1.5 per cent pa of trading costs eats 3.2 per cent of your capital every year. That means over 15 years the market has to grow by 60 per cent just for your money to stand still!
When you buy a fund, ask what the Portfolio Turnover Rate (PTR) is. It can usually be found in the simplified prospectus. It tells you how much of the fund the manager traded in the last 12 months. 100 per cent means the manager bought and sold the equivalent of everything in the fund, 200 per cent means they bought and sold everything twice in a year. Active management may add value but it struggles when the costs of turnover (the buying/selling, commissions etc) are high. According to the Financial Services Authority, the trading costs associated with 100 per cent turnover of a typical UK Equity fund will cost you about 1.5 per cent. (source: FSA).
As Neil Woodford, the UK's most successful fund manger said recently: "There are lots of busy fools creating huge friction, where the costs are borne by investors."