March 10, 2018
Growing up, I always heard the word ‘tax’ floating around in the air, within the family, at school, on TV…it was a common topic of conversation everywhere. I didn’t know what it meant, only that it was a fact of life and I knew that people had to pay it, often with a grimace on their faces while they filled out their tax returns.
See also: Link to our article on the topic from last year – You Absolutely Need to Open This Account
I always associated tax as being one of those necessary evils. Governments tax to accumulate enough money to spend on maintaining the livelihoods of its people. Good in principle, right? Yet it’s still somewhat unpleasant given that money in your pocket is initially being taken away from you with no guarantees of getting it back in full. Nobody likes less of something they value.
So, on the flip side, when governments don’t tax, they try to incentivise behaviour with the extra money that you can keep.
That’s exactly what the ISA is built to do. Coming from Australia, I thought the concept of investing tax-free was just too good to be true. Every year the maximum amount you could stow away in an ISA for the purposes of tax-free investing just kept growing. This year, it’s reached a whopping £20,000.
For those who haven’t opened an ISA, now is a good time because the end of the 2017 tax year is approaching fast. If you open one before 6 April and deposit as little as £100 to a maximum of £20,000, then deposit another £20,000 a day after, you could very quickly end up with £40,000 completely protected from the taxman forever. Plus, the government is fully supportive of your master plan on escaping tax.
While you could open a cash ISA, I wouldn’t recommend it given that the current rates offered are just too low to be worth your while (see image: my HSBC rate is currently set at 0.45%).
They only narrowly beat inflation if at all. Consider opening a stocks and shares ISA, which in addition to being an effective means of storing cash, allows you to invest in a wide range of traditional investments.
Having said that, you don’t need much knowledge about investing in order to benefit from an ISA.Providers often have ready-made portfolios based on risk appetite and investment goals. If you are in your 20s or 30s you’d more likely go for a growth portfolio, i.e. you’re looking for your investment to grow over the long term and you don’t need to cash out now. You would most likely have a higher risk appetite and invest in mostly equities in search for higher returns. On the flipside, if you are in your 40s or 50s, you’d be more suited to an income portfolio, i.e. you’re starting to think about getting a regular monthly passive income from your investments to replace your working salary. As you’re looking to cash out, you want to have the stability of a regular pay-out so your risk appetite would be lower. A higher weighting on bonds vs. equities should do the trick.
There is nothing too fancy about this. Of course, you could get someone to do this for you but be prepared to pay. There will be fees due to the ‘active’ management of your portfolio on your behalf. Why not do it yourself? A good rule of thumb, I coined for myself, was to invest (100 – AGE)% in equities.This equity-age rule suggests that, at 20, I’d invest at least 80% in equities, while at 50 that would be 50% in equities and 50% in bonds.
With youth comes a feeling of invincibility, but I’ve grown to realise that it is often very difficult to consistently beat the market. Beating the market requires you to time the market so that you take advantage of the opportunities and escape the pitfalls. (Just take a look at this tool)
Often I don’t want the emotional hassle (in addition to what I get from crypto on a daily basis!) so I end up investing in a low-cost index fund such as the Vanguard US Equity Index Accumulation Fund that safely returns 10% on average across my lifetime.
Low-cost index funds give good returns and cost very little, often an annual fee of 0.05% – 0.10% compared to an actively managed fund that steals at least 10x that figure.
Even though you might not want to invest at this point, simply opening a stocks and shares ISA and keeping cash in there is a good way to prepare for when you do want to invest. Given the market turbulence we are seeing right now and calls for a market correction to respect the 10-year cycles of peaks and troughs, you can’t be blamed for wanting to stay on the sidelines. It is certainly what I’m doing right now.
The key takeaway from what I’m writing about today is to take opportunities to save on tax when the government is encouraging it. The increasing limits over the past few years have reinforced the commitment to allow taxpayers a haven for their investments. So, open a tax-free stocks and shares ISA by 5 April and make the most of your £20,000 allowance before it’s too late.
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