ISAs and tax efficient investments – the easily lost 22.5%

We should all be conscious about the tax efficiency but as Peter McGahan cautions; choose your investment vehicle wisely.
ISAs and tax efficient investments

There are many ways to invest your money, and to do so efficiently, and tax efficiently. Here, we look at ISAs and tax efficient investments, highlighting the advantages and hazards you must weigh before acting.

From a tax efficiency viewpoint, ISA’s ensure that all gains in your investments are tax free, as do pensions.

A Unit Trust, Open Ended Investment Company (OEIC), or Investment Trust have the benefit of gains being offset against losses elsewhere, or using your annual Capital Gains Allowance each year.

Bonds allow gains to be rolled up each year without the need for tax to be paid at that time, and every time you decide/need to rebalance your investments there is no tax event created.

In short, there are many ways to ensure you pay just the tax you need to, as long as you take regular advice from an Independent Financial Adviser, your accountant, especially as tax laws change.

However, easy mistakes can be made when investing where we choose the wrong investment vehicle to achieve our objectives.

Assuming we use our ISA and pension allowance from a tax benefit/point of view, the choice of investment vehicle can turn to that of the OEIC/Unit Trust/Investment Trust.

There are clear advantages to both, but investors should look to choose the most appropriate vehicle for what they are investing into.

When building your portfolio, you, or your adviser should be negatively correlating your investments. I.e. you buy a very good ice cream company and a very good Wellington boot company. Normal conditions mean you do well, but along comes a heatwave when wellington boots become as popular as a politician.

As you are negatively correlated, the ice cream company’s gains balance out the complete lack of business in the Wellington boot Company.

Investment advisers/companies should do this for you, but I often see portfolios positively correlated i.e. an ice cream company and a sunglasses company.

They will surge in certain market conditions due to that bet, but that can flip just as quickly.

It’s rare to be able to call where a market is going and to invest with such a gung ho fashion, so the key is to have the stabilisers out to ensure if you are blind sided with a powerful wave, your investment journey is a safe one. Negative correlation.

Property is considered to be a negative correlation to equities/stocks and shares.

Naturally when building your portfolio, your adviser might set a percentage for property, but the choice of vehicle to invest into can make a significant difference to your returns.

You invest into a Unit Trust into property and later decide you want to encash some of your investments for your extension/holiday.

Unfortunately, at that point, the market is under pressure, and the fund needs to protect their investors as there are many encashments, so it closes its fund to redemptions – Woodford et al.

As there are so many redemptions, such a fund has to begin a fire sale of its assets.

If you are a buyer and you know an investment fund needs to release cash, you are in a superb position to control the price, as you can see the balance sheet of the OEIC/Unit Trust, where they are invested in, and know they need cash.

Meanwhile an Investment Trust, as a closed ended vehicle, could, if it wanted, whenever it wanted, encash any property they needed, so no fire sale.

Moreover, the Investment Trust can gear. Gearing means the trust can borrow money to make purchases. So, if we consider the above example, the Unit Trust HAS to sell assets, and the Investment Trust might own such assets, or want them.

The Unit Trust sells them at a significant discount, whereas the Investment Trust can, and does borrow money, and buys them at a fire sale price, something the OEIC cannot do.

The market returns to normal, and the Unit Trust has significantly underperformed the Investment Trust yet they were invested in the similar assets.

An example of that is Picton Property versus M&G Property.

Over the year Dec 2018 to Dec 2019, Picton Property returned over 15%, whereas M&G Property lost 7.5% for the exact reason above.

Choose your investment vehicle wisely.

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Last modified: June 22, 2021

Written by 2:11 pm News & Views