How to invest to buy a home

If you’re just starting your first job or receiving a pay rise, your next goal might be to save up for a first or larger home. If you don’t have the finances in place, realistically this is a goal for maybe five to 10 years’ time. But to be able to achieve it within such a timeframe, the way you save and invest from day one is key.

To lose as little as possible of what you save to tax,  aim to hold the money you set aside in individual savings accounts (Isas). Cash and investments within Isas grow free of tax. You can also sell these assets within them without incurring capital gains tax (CGT) and withdraw from Isas tax-free.

If you’re between age 18 and 40 and saving for a first home, consider using a Lifetime Isa (Lisa). You can save up to £4,000 a year into these and the government pays a bonus of 25 per cent of what you put in – up to £1,000 a year. This bonus doesn’t count towards your total annual £20,000 Isa limit so you can save an additional £16,000 into other types of Isas and, in effect, put £21,000 a year into a tax-efficient shelter.

However, there are a number of restrictions including not being able to buy a first home worth more than £450,000 and having to take out a mortgage in conjunction with the Lisa. So if a Lisa isn’t an option for you, or you have more than £4,000 to invest, save into stocks and shares and/or cash Isas.

It is wise to hold higher-returning investments, such as stocks and funds, within Isas because they can incur more tax. But if you can save more than £20,000 a year you can invest within a general investment account, though this will be subject to capital gains and dividend taxes. However, from April 2024, the dividend allowance will enable you to earn £500 in dividends a year tax-free and you will be able to make gains of up to £3,000 a year before incurring CGT. You can also offset losses from current and previous tax years.

The portion of your savings that is to be held in cash should go into high-interest bank accounts. You could initially lock some of it up in fixed-term accounts, which generally pay higher rates of interest, or accounts into which you have to pay a minimum amount on a regular basis, as these also offer higher interest rates. The personal savings allowance enables you to earn £1,000 in interest tax freem if you are a basic-rate taxpayer or £500 if you are a higher-rate taxpayer tax free. Additional-rate taxpayers must pay income tax on all their interest.

How to invest

If your investment timeframe is more than five years, most of your savings should go into investments. But, the exact amount you have in these depends on your capacity for losses. Rob Morgan, chief analyst at Charles Stanley, says you cannot take too much risk, because if stock markets fall dramatically you will be time-limited on how long you have for markets to recover.

"Taking some risk could be worthwhile, as it's likely you'll get meaningful inflation-beating returns – something you won’t receive with cash. A part investment-part cash strategy could be more appropriate, especially if the timeframe is closer to five years than 10," he says.

To determine the proportions, set a target amount which you want to save, for example £150,000 to cover the deposit and stamp duty. Then consider your timeframe, for example, eight years, and work out how much you can save each year and what return it needs to make to get to £150,000.

It’s important to be realistic about investment returns. The average annual return for a portfolio with 60 per cent in stocks and 40 per cent in bonds was 6.1 per cent over the 10 years to the end of 2022, according to Vanguard.

But you may have different proportions with a very heavy focus on cash in, say, the two years before the house purchase, and fees and charges eat up some of the returns. Equity markets may also perform differently over your period of investment to this period. John Moore, senior investment manager at RBC Brewin Dolphin, says you should also factor in a tolerance for variation – how long you can extend your investment timeframe to get to your desired return. The longer this is, the more you can invest in volatile assets such as stocks.

Extending your time horizon and/or the amount you put in each year may be necessary, or if you cannot increase either of these factors you might have to buy a property of a lower value.

If you make regular investments such as once a month – rather than putting in a large lump sum – Morgan says that you could “up the risk" and invest more in stocks. This is because when you invest on a regular basis, you buy shares or units in funds at a range of different prices, both when they're cheap and when they're expensive, giving you a range of returns that average out. This is known as 'pound cost averaging'. “Monthly investments should smooth out your entry value to investment,” explains Moore.

For a broad guide to the sort of percentage ranges you might have in each asset class, see the Investors' Chronicle Alpha asset allocation models for different risk levels.

What to buy

For stocks, you could buy low-cost passive tracker funds or exchange-traded funds (ETFs) that track a broad index such as the MSCI World, FTSE 100 or S&P 500. These are suitable if you cannot or do not want to spend much time researching and monitoring individual investments. They also offer exposure to many stocks so with just one global fund or a few regional funds you can have a well-diversified portfolio.

Or you could invest in a risk-rated diversified fund such as one of the five Vanguard LifeStrategy funds, which allocate between 20 and 100 per cent to stocks, with the remainder in bonds. “A multi-asset fund that blends stocks and bonds, and perhaps other investments [provides] a ready-made diversified portfolio,” says Morgan. “Importantly, this is periodically rebalanced by the manager to manage risk. It’s also easy to invest regularly and to switch from a more adventurous fund to a more conservative one as time progresses.”

You could just hold one of these or a global equities tracker fund as the investment component of your savings – at least when you start out. You shouldn’t hold many individual investments in a portfolio with a small value because fund charges and trading fees would eat up a high proportion of it. But as the portfolio size grows you could diversify it with other funds. “Start with market trackers or simpler funds, then build [the portfolio] up with more specialist investments," says Moore.

If you wish to try to outperform the stock market and are prepared to do more research and monitoring, Moore suggests a growth-orientated fund such as Scottish Mortgage Investment Trust (SMT) and perhaps some allocations to thematic or sector funds focused on long-term growth areas such as technology or healthcare.

Regularly check what your portfolio is doing relative to your target, but stick to your chosen asset allocation and investment plan. For example, if technology stocks are doing really well don’t be tempted to double your allocation to them if it isn’t consistent with your risk appetite and chosen asset split. Regularly investing a set sum each month into certain investments can be a good way to avoid this kind of temptation.

How to prepare for a purchase

As you get closer to a house purchase you should have more in cash than investments to avoid losing what you have spent years building up. “Cash offers certainty and some return, and is the mechanism via which you will pay for a home,” says Moore. “Everything that is different to cash is a risk.”

Morgan says that one approach could be to go from 80 per cent in stocks and 20 per cent bonds and cash, to 20 per cent in stocks and 80 per cent bonds and cash over the course of five years. He suggests starting to de-risk five years before a purchase if you invested a lump sum, but adds that this could be shortened a little if you’re making regular contributions as these help to mitigate the effects of market falls.

"You could stop putting your regular savings into higher-risk investments and put them in lower-risk investments instead to gradually change the shape of the portfolio,” he says. If you hold a higher-risk multi-asset fund you could switch it into a lower-risk fund in the provider’s range “at appropriate intervals, for instance every 18 months to two years, and then progressively move into cash with two to three years to go,” he adds.

Moore argues that a key factor should also be how close you are to your target amount. For example, if your investments do well and you get close to your target sum, you could start reducing risk sooner. If you have almost reached your target amount, even if you still have four to five years until the house purchase, up to 90 per cent could be moved into cash. Conversely, if you are struggling to get to your set sum, more might need to stay in potentially higher-returning investments for longer.

One way to de-risk could be to sell the investments outside Isas that are liable for CGT and take advantage of your allowances each year. This way you don’t lose savings to tax and prevent a large liability from building up.