A junior colleague recently asked me when she should start seeking financial advice – should she speak to an adviser early in her career or wait until she has accumulated some savings? It is question many people ask. I have worked in the financial services industry for more than 20 years and, having been an independent financial adviser for many of those years, I have met and managed the funds of people who have saved and those who have not. As you can imagine, the savers look forward with confidence to retirement while the non-savers do so with fear and trepidation.
As dentists, you will know that regular check-ups are essential to maintain oral health. The same is true of your finances. So my answer to when to seek financial advice is the earlier the better.
The starting point for any financial adviser is to create a profile of you, the client. This is done by collecting information about your personal circumstances and current financial situation. From this profile a financial plan is created to help you achieve your desired lifestyle – allowing for any disasters, of course, that may arise. Your adviser can then make recommendations as to how to use your finances.
They will cover your assets, investments, liabilities and income. The way you spend your money is also a vital aspect of the analysis, so a review of your short- and long-term expenditure will help establish the plan’s robustness.
‘Wealth management’ is not just about investing available cash in pensions or, indeed, any single source. Its primary function is to make the best use of available assets given the restraints of liquidity and tax efficiency. It is also about putting these assets to the best possible use, as and when opportunities arise and when needs must. Investment is a means to an end. It is about using your capital to create more money, either through income or capital growth.
The long-term capital growth and income associated with investing in equities has, on average, outperformed returns from the investments that rely on interest rates. Over periods of sustained economic growth, investors in equity-based investments have seen their capital increase substantially. Also, equity-based investments have proved to be a good defence against inflation. There are four main aspects to increasing capital growth.
Inflation is normally the most serious threat to the long-term capital value of savings. Inflation protection is usually achieved with asset-based investments, which historically have offered the best prospect of growing income and capital.
Spreading them thin
You can protect your investments by spreading them across various investment vehicles such as unit trusts, investment trusts, and open-ended investment companies and managed funds of insurance companies, all of which are widely diversified. Full-time fund managers have sources of market information, resources and investment skills that few individuals can match.
Importance of time
One of the most fundamental aspects of any equity-based investment is that of time. While a particular fund’s past history should not categorically be taken as read, the long-term overall performance has to be seen in the context of short-term fluctuations.
And while excellent short-term gains can sometime be made, the fundamental principle of any equity-based investment is to accumulate good quality capital growth over a period of time, not one or two years but five to if necessary.
Attitude to risk
Any investment capable of capital growth also has the potential for capital loss. The extent to which you are prepared to expose your capital to risk is an important factor in determining potential growth. So before you make any investment decision you should consider the level of risk you are willing to take.
When building an investment portfolio, inflation, risk, the time scale of the investment and the tax element all have to be considered. Achieving a balance between the four is essential and none of them should be considered in isolation.
With the relevant importance of each factor likely to change over time, regular reviews of your financial affairs are essential, so seek independent financial advice. Also, while the reduction of tax – or indeed its avoidance – is important, the tax element is probably the most distorting of these factors and should not be allowed to dominate the investment decision.
Remember that while a particular investment may look impressive; it is unwise to ‘put all your eggs in one basket’. The best philosophy for prudent fund management is to split the funds between different types of investments, not only to achieve the ultimate goal of good quality growth but to mitigate risk factors as well.
Different types of assets, such as equities or bonds, behave in different ways. The first step in forming any investment strategy is to achieve the right balance between the major asset classes. This ‘asset allocation’ is fundamental to meeting your investment goals in the medium and long term. In fact, asset allocation can be as important as the choice of individual funds themselves.
As dentists, you are eligible for membership of the NHS pension scheme, so this is the first port of call for your disposable income. As a member of this scheme you will be entitled to pension benefits at retirement which depend on your length of service and salary.
In the dental industry, where remuneration is high, your pension will form a substantial part of your retirement income. But will it be enough to maintain your standard of living at the level of income you enjoyed during your career?
One starting point here is simply to save regularly. To make this tax-efficient you could consider using your Individual Savings Account (ISA) allowance. With an ISA you can save up to £7,000 in a tax year (6 April to 5 April) and not pay tax on the income you receive from the plan or the gains it achieves. This is an excellent way to save.
ISAs can be split into two components – a Mini ISA and a Maxi ISA. Any ISA can be made up of an investment in cash, or longer-term investments such as stocks and shares. In each tax year you can invest either in one Maxi ISA, which can include all of these types of investments, or two Mini ISAs – one for cash and one for stocks and shares.
There are two types of Mini ISA – a cash ISA, and a stocks and shares ISA – and you can open each ISA with a different ISA manager if you wish. The amount you can invest in each tax year is fixed – up to £3,000 in a cash ISA and £4,000 in a stocks and shares ISA. But you cannot invest in more than one Mini cash ISA or more than one Mini stocks and shares ISA in the same tax year. This would be a good starting point for regular monthly savings.
A Maxi ISA can include both cash and stocks and shares. Whichever way your investment is split, it counts as one Maxi ISA, so you can open only one Maxi ISA in each tax year. The total amount you can invest is £7,000 a year and you can invest up to £3,000 of this in the cash element. By using your ISA allowance on an annual basis you have the scope to build a substantial fund for retirement or, before then, use it to help fund such things as school fees. I have found this to be a great source of providing tax-efficient income for clients, particularly at retirement. When pension levels bring them into the higher-rate tax bracket, tax-free income of any sort is very welcome.
You could also consider investment trusts. These are public limited companies whose shares are listed on the London Stock Exchange. Investment trusts enable you to spread your risk by holding a wide range of investments in hundreds of companies.
Each investment trust company employs fund managers who use specialist research facilities to help them decide which shares to buy, when to buy and when to sell. The managers keep abreast of investment opportunities in stock markets in London and around the world. They are accountable to the directors of the investment trust company who in turn are accountable to the shareholders.
Because of their structure and because their costs are low, investment trusts have particularly good long-term potential for growth. This makes them ideal investments when planning years ahead. I often recommend regular and lump-sum investments in unit trusts as part of a financial portfolio. Unit trusts are investment vehicles which pool contributions from their investors and the total fund is then managed by specialist fund managers, whose task it is to manage the ‘investments’ of the fund to make investment profits. These profits increase the value of the fund, increasing the value of each investor’s share. Of course if the fund suffers losses then the value of investors’ shares falls, as does the price of the units.
In general, unit trusts invest primarily in equities and often specialise in a particular sector or geographical area. Dividends are paid to unit holders that reflect the dividends received on the underlying investments. The dividends are liable to income tax and are subject to the same tax treatment as dividends on direct share-holdings. The unit trust does not itself pay tax on its capital gains, but on encashment any gain made by the investor is subject to capital gains tax (CGT), under normal CGT rules, including the annual exemption and taper relief.
Most reputable financial advisers have good working relationships with firms of stockbrokers and, where
appropriate, give advice on the investment of direct equities as a means of building an investment portfolio.
One of my main reasons for recommending a portfolio of investment trusts, equities, unit trusts and OEICs is that by placing funds in such holdings my clients have scope to use their CGT annual allowance in years to come by way of disposals of these holdings, which makes this an efficient investment vehicle to consider within an overall investment portfolio.
It is a common feature of tax planning, that individuals should, where possible, aim to use their CGT annual exemption (£8,500 for 2005-6) because it cannot be carried forward and, if unused, is just wasted. Married couples have even greater scope to make tax savings because more than £16,000 worth of gains can be realised without a tax liability on jointly owned assets – clearly a beneficial feature and one that could be exercised in years to come.
What I have discussed here is only a small area of investment planning and does not take into consideration the many areas or types of investment vehicles. But what I hope I have been able to highlight is that financial planning should not just be dealt with at retirement but should be considered throughout your career to take account of accumulating wealth, ensuring sufficient life/protection cover, inheritance tax planning, investment planning, mid-career planning and retirement planning.
When seeking advice, however, look at your overall financial position so that your adviser has a clear picture of your financial affairs, aims and objectives. This makes for prudent and efficient financial planning, as it looks not only at your immediate needs but your long and short term needs too. Perhaps you should think about arranging your own financial check-up soon.
Anne Alexander is associate director and head of investments at Campbell Dallas Financial Services. Call 0141 942 6060 or email [email protected] for further information.