Jump to your preferred section:
- What is investing and why do people invest?
- What should you think about before investing?
- What does ‘capacity for loss’ mean?
- What does it mean for an investor to consider their ‘investment objectives’?
- What does it mean for an investor to consider their knowledge and experience?
- An introduction to some of the different asset classes
- An introduction to investment funds
- Five questions to ask yourself before investing
- An introduction to tax-efficient investments
- Individual Saving Accounts (ISAs)
- Business Relief for Inheritance Tax
- Enterprise Investment Scheme
- Seed Enterprise Investment Scheme
- Venture Capital Trust
What is investing and why do people invest?
Investing is the act of buying financial assets which may increase in value over time. It is a way of making capital work harder for investors and potentially generating a better return than that which would typically be offered by a savings account.
Investing could help investors achieve their long-term financial goals and help work towards potential financial independence.
The main benefits of investing are the potential to build wealth, protect capital against inflation and earn additional income.
Investment returns are not guaranteed, and they can fall as well as rise in value. You could end up with less than you invested.
What should you think about before investing?
An investor should consider prioritising paying off any debts before considering investing. The interest rates charged on any debt is likely to exceed the rate of return on any potential investment.
An investor should also build up an emergency cash fund before investing to be ready for any potential emergencies that put a strain on their finances.
Investors are typically recommended to build up an emergency fund that can cover any living expenses for a period of between three to six months if needed.
What does ‘capacity for loss’ mean?
The FCA defines an investor’s ‘capacity for loss’ as their ability to absorb falls in the value of their investment. If any loss of capital would have a materially detrimental effect on the investor's standard of living, this should be considered in assessing the risk that they are able to take.
For an investor to consider their capacity for loss, they should consider their assets and monthly incomes against their outgoings. This ensures that they are better placed to truly assess their individual financial situation and their total investable assets.
What does it mean for an investor to consider their ‘investment objectives’?
The investor should consider their investment objectives and goals in making investments. Examples of investment objectives could include:
- Managing and growing wealth
- Saving for a life event
- Inheritance planning
- Retirement or living in retirement
Understanding the broader investment objective is helpful as it can further break down an investor’s investment strategy. For example:
- Does the investor require capital and/or income from their investments?
- Does the investor have more than one need or objective?
- What are the investor’s priorities?
- What is the investor’s time horizon?
- What is the investor’s expectation of returns compared with risk that there are prepared to accept?
What does it mean for an investor to consider their knowledge and experience?
An investor should consider their knowledge and experience in relation to the investment being considered. This should include whether they have adequate experience and/or knowledge in the relevant investments and the nature and volume of any previous relevant transactions.
Diversification
‘You should avoid putting all your eggs in one basket’.
This saying is very applicable in the world of investments. Spreading money across a different range of investments can help reduce the investment risk. Should any one investment perform below expectations, the performance of other assets in the portfolio may help to offset the impact of losses.
We would strongly recommend that investors review the FCA’s excellent educational article on diversification for further information before considering investing.
An introduction to some of the different asset classes
Bond: A bond is essentially an IOU (a phonetic acronym of the words "I owe you" - a document that acknowledges the existence of a debt), where an issuer lends money to a borrower (the holder) in return for a promise to repay the money with interest by a specific date. Bonds are typically issued as a means of raising finance.
Shares: Shares are units of ownership in a company. Shareholders usually have voting rights and can vote at company meetings, such as appointing directors and auditors and approving proposed dividends and takeovers.
Cash or cash equivalents: A cash or cash equivalent investment is typically seen as a lower risk, lower return option than bonds or equities. Cash held in a savings account provides a high level of security for investors' money where a deposit protection scheme exists. The only returns are typically in the form of interest payments, which can be low. Additionally, the purchasing power of the cash may be eroded by inflation, especially if it is held for a longer period.
Alternative Investments: Alternative investments are financial assets that do not fall into the more traditional asset classes. Alternative investments can be useful in a portfolio as they provide diversity from more traditional investments. They may be less liquid than their traditional counterparties and may require a longer investment period to realise any potential gains. ]
An introduction to investment funds
An investment fund is a collective investment vehicle that pools money from several investors to invest in assets collectively. The fund is likely to be managed by a professional fund manager who should manage the raised capital with a view to investing for the benefit of the investors, in line with a defined investment policy.
There are several potential benefits and disadvantages to investing in a fund vs. investing directly in the underlying investments. We have highlighted some considerations below:
- Diversification: Investing in a fund means that you will be pooling your capital alongside other investors, spreading your investment across a wide range of assets and lowering your investment risk.
- Exposure: Specialised funds may give exposure to specific markets which investors may not otherwise access.
- Fees: The fees charged on a fund can vary hugely depending on the investment strategy employed by the relevant asset manager and the structure of the underlying investment vehicle. For some funds, there may be a wide range of associated costs and charges, which may not always be sufficiently clear to the end investor.
Five questions to ask yourself before investing
The Financial Conduct Authority recommends that individuals considering investing should ask themselves 5 questions before investing.
We have summarised the FCA’s relevant questions below, but we would strongly advise individuals considering investing to review the FCA’s article in full, as we view this as very useful guidance for any potential investor.
- Are you comfortable with the level of risk the investment poses? Can you afford to lose the money invested?
- Do you understand the investment, and can you get your money out easily if required?
- Are your investments regulated? Will you have access to the Financial Services Compensation Scheme or Financial Ombudsman Service if things go wrong?
- Are you protected if the investment provider or your investment adviser goes out of business?
- Should you seek financial advice to help you understand the investment and its risks and opportunities?
Investment returns are not guaranteed, and they can fall as well as risk in value. You could end up with less than you invested.
An introduction to tax-efficient investments
This article is intended to introduce some of the most mainstream tax-efficient investments and tax reliefs for investors to consider. Downing LLP does not provide investment or tax advice. The information within this document has been provided for educational purposes only and does not constitute a financial promotion. If investors require further information, they may consider discussing with an appropriately qualified adviser.
Individual Saving Accounts (ISAs)
Investors can save, tax-free, with ISAs subject to annual limits. In the 2023 to 2024 tax year, the maximum an investor can save in an ISA is £20,000. ISAs allow investors to shield their savings from income tax and capital gains tax.
There are four types of ISAs, and investors can put money into one or more of the below ISAs per tax year.
A cash ISA is a saving account that offers tax-free interest payment. This means that investors will be able to keep all the interest they will earn.
A stocks and shares ISA is an investment account that allows investors to invest in a wide range of investments. Any investment gains made within this ISA will be tax-free.
An innovative finance ISA allows investors to utilise their annual ISA tax-free allowance whilst investing in peer-to-peer lending and crowdfunding investment opportunities.
An investor can use a Lifetime ISA to buy their first home or save for later life. An investor must be over 18 but under 40 to open a Lifetime ISA. Investors must have made their first payment into the ISA before they are 40.
A lifetime ISA allows investors to invest up to £4,000 each year until they are 50. The government will add 25% bonus to investors savings, up to a maximum of £1,000 per year.
Investors may withdraw money from the ISA for the following reasons:
- To contribute to buying their first home if meeting the necessary criteria.
- Saving for later life, investors can take the savings out when they are 60 or over.
- Investors are terminally ill with less than 12 months to live.
Investors who withdraw savings for any other reasons may be making an unauthorised withdrawal which will result in a withdrawal charge of 25%.
Business Relief for Inheritance Tax
Business Relief (BR) is an established tax relief that allows investors to claim Inheritance Tax (IHT) relief on qualifying businesses and business assets which they own.
IHT is the tax on the estate of someone who has died and whose estate exceeds the inheritance threshold (Nil Rate Band) of £325,000.
BR reduces the value of a business or business asset that an investor owns in the calculation of their IHT liability. To receive BR, the investor must have owned the qualifying business, or qualifying business asset, for at least two years and at the time of death.
Not all businesses or interests in a business will qualify for BR. Investors can claim 100% BR from:
- A qualifying trading business or interest in one.
- Shares in a qualifying unlisted company or shares in a qualifying company listed on the Alternative Investment Market (AIM) of the London Stock Exchange.
For more information regarding what does and what does not qualify for BR, investors should review the Government’s website or speak with an appropriately qualified adviser.
BR can be a useful form of tax relief that investors may be able to utilise as part of their estate planning process. Still, it is a complex area, and qualifying investments may not be suitable for everyone.
Investors looking to learn more about this area, or estate planning generally, may wish to consider discussing this with an appropriately qualified adviser.
Enterprise Investment Scheme
The Enterprise Investment Scheme (EIS) is a government-driven initiative designed to provide investment in early-stage companies through venture capital funding. It does this by providing a range of attractive tax reliefs to qualifying individuals who subscribe to shares of EIS-qualifying entities. To benefit from the tax reliefs available, investors must hold qualifying shares for three years.
The tax reliefs available to EIS investors can include:
Investors can claim up to 30% income tax on a maximum annual investment of £1 million in a single year or £2 million for knowledge-intensive companies.
- Exemption from Capital Gains Tax
If an EIS-qualifying investment has been held for three years, any capital gain realised on the sale of the qualifying asset will be exempt from Capital Gain Tax, proving Income Tax relief has been claimed and has not been withdrawn.
Where an investor has made a gain that would otherwise be subject to Capital Gains Tax, they can defer this charge by reinvesting the profit into an EIS-eligible investment within three years before the gain is realised and up to one year afterwards. The investment must be within the maximum EIS investment thresholds.
Providing a shareholder has owned shares in an EIS investment, for at least two least two at the time of death, and certain conditions are met, EIS may qualify for IHT Business Relief of 100%.
EIS investments are high-risk, high-reward types of investment. Loss relief enables investors to offset a loss on an EIS investment against their income tax or capital gains tax bill, depending on which is more appropriate for their individual circumstances.
Seed Enterprise Investment Scheme
The Seed Enterprise Investment Scheme (SEIS) was introduced in 2012 by the government to complement EIS, it’s intended to recognise the difficulties that early state companies face through attracting investment as it offers tax relief at a higher rate than that offered by SEIS.
Investors must hold qualifying shares for three years to benefit from the relative tax reliefs. The attractive tax reliefs offered by SEIS include:
Eligible investors can claim income tax relief at the rate of 50% on a £200,000 annual investment.
If a SEIS-qualifying investment has been held for three years, any capital gain realised on the sale of the qualifying asset will be exempt from Capital Gains Tax, proving income tax relief has been claimed and has not been withdrawn.
Where an investor has made a gain which would otherwise be subject to Capital Gains Tax, they can treat a maximum of 50% of the gain as exempt from Capital Gains Tax, where they have reinvested all or part of the amount of the gain in qualifying SEIS shares.
Providing a shareholder has owned shares in a SEIS investment, for at least two years prior to death, and certain conditions are met, SEIS investments may qualify for IHT business relief of 100%.
SEIS investments are high-risk, high-reward types of investment. Loss relief enables investors to offset a loss on a SEIS investment against their Income Tax or Capital Gains Tax bill depending on which is more appropriate for their individual circumstances.
Venture Capital Trust
The Venture Capital Trusts (VCTs) is further government-driven initiative designed to provide investment in unquoted smaller, higher risk trading companies. It does this by providing a range of attractive tax relief.
VCTs are listed investment trusts which are typically managed by an FCA authorised manager. Investors subscribe for shares which enables the VCT to onward invest in qualifying trading companies which provides them with capital to develop and grow.
The attractive tax relief include:
No Capital Gains Tax is payable on gains made through selling ordinary shares in VCTs.
Eligible shareholders can claim Income Tax relief at the rate of 30% up to £200,000 annual investment, provided their shares are held for least five years.
No income tax is payable from dividends from ordinary shares in VCTs.
