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November 23, 2012 6:00 pm
Our imaginary investors this week are a professional couple, perhaps in their forties.
They have been homeowners for more than a decade and have made substantial inroads into their mortgage, although they are some way from paying it off.
They both have some workplace retirement provision and their employers have relatively good sick leave and health insurance provisions. They have some cash savings for things like holidays and rainy days.
A five-year savings bond is coming to an end, and they also have a friendly society policy maturing.
Add those to various dormant Isas, and they have £100,000 between them, which they’d like to consolidate to help fund tertiary education for their two children, who are in their early teens. What should they do?
Ben Yearsley, Head of Research, Charles Stanley Direct:
The first course of action is to maximise the couple’s Isa allowance until all capital is tax sheltered. The next question is clearly investment strategy, and while making assumptions about equity growth is never easy, if you factor in dividend yields of 4 per cent inflation of 2 per cent and productivity gains on top, this gives a potential equity return of 7-8 per cent per annum. If this happened over the next five years the £100,000 pot would be worth £140,000 at 7 per cent growth, which should be enough to fund the children’s university education but would leave the parents with nothing.
My strategy would be in two parts: the first to run to the start of university, the second to get them through university and leave some capital over. To do this, I would go for an equity-bond split of 80/20, with the equity portion of at least 50 per cent UK.
I would have a mix of equity income funds from the likes of Invesco Perpetual Income, JO Hambro Equity Income and Finsbury Growth & Income. These can be mixed with some overseas funds managed in a similar manner, such as First State Global Listed Infrastructure.
I would then add in other UK based funds such as Liontrust Special Situations and the Axa Framlington UK Opportunities Fund; both have great managers and are skewed towards quality companies. I would then add in a few higher risk funds, or certainly funds in higher risk areas such as technology and Asia.
Finally I would add a bond element – maybe 15-20 per cent, and in high-yield and strategic bond funds, such as Kames High Yield Bond, M&G Optimal Income or Jupiter Strategic Bond.
Initially, I would reinvest income within the Isa wrapper, but switch to distributing it once the children start university. This should make the capital last longer.
James Maltin, investment director, Rathbones Investment Management
Our starting point here would be the structure. This couple should ensure they benefit from the tax breaks the government offers to reduce the burden of taxation. The simplest and most flexible such break is the individual savings accounts (Isas); based on current rules and given that some money is already in Isas, the couple could probably shelter the entire £100,000 between them over three years.
Even if they are higher-rate taxpayers, they are not subject to any further income or capital gains tax and can add funds each year. The maximum permitted per adult currently stands at £11,280, making a combined allowance of £22,560 for this fiscal year with a further £22,560 on April 6 2013 (assuming no change in the allowance): a total of £45,120. Additionally, they can contribute £3,600 annually into junior Isas for each child, making a total of £14,400 over the next five months. In this way, they can shelter £59,520 in Isas. Funds should remain readily available in cash until the Isas have been subscribed. The balance of £40,480 can be added to the Isas in 2014 and 2015. Until then, it should also remain in cash, but in a 3-year building society deposit or “bond”. Given the current economic and market uncertainty, it is no bad thing to spread the investment over a number of years.
Once the funds are safely within a tax-free harbour, the accounts could be consolidated and the portfolio managed with an investment horizon of 5-8 years, given the couple’s objective of meeting the costs of their children’s tertiary education. To achieve this, we would suggest an asset allocation as follows: 15 per cent in index-linked government bonds, 5 per cent in conventional investment grade bonds, 20 per cent in UK equity, 30 per cent in international equity and 30 per cent in alternatives – by which we mean property, private equity, commodities and, on a very selective basis, hedge funds. Exposure to all these assets would be via funds, managed by those we consider to be among the very best in their respective fields.
Stephen Vakil, managing director, Quilter
The starting point for investment planning is to ensure there is an adequate cash reserve, and even though the couple have a “rainy day reserve”, I would be minded to first check that it’s adequate. There’s little worse than having to liquidate investments to realise emergency cash.
We’ve assumed that of the available funds, £50,000 are held in Isas and £50,000 is the total of the various maturing policies. On that basis, we would recommend that these are consolidated into as few vehicles as possible. The Isa wrappers should be retained to take advantage of these tax-efficient vehicles but the investments could be managed to one overall mandate if appropriate.
We believe that strategic asset allocation is the most important decision when constructing portfolios and we would need to ensure that we invest in the appropriate asset mix and that this continues to remain suitable over time, particularly in light of their requirement to help fund tertiary education.
For this size of investment, we would recommend investing in a broad range of collective investments and, given the time horizon, we would favour a bias to equities given their attractive valuation relative to fixed income. We would incorporate funds with different investment styles and include allocations to overseas equities where we feel there is good potential for capital growth in particular.
The portfolio would also include fixed-interest investments such as corporate bonds along with alternative assets to ensure sufficient diversification. However, we’d be keen to avoid the longer-dated end of the fixed-interest spectrum.
We’ve also assumed that the couple will wish to continue building the fund and consider that automatic Isa subscriptions each year would be advisable.
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