DENNIS & MARGARET INVESTMENT COMPANIES

Transcription

1 DENNIS & MARGARET INVESTMENT COMPANIES 18 July 2016 OBJECTIVES 1. To pay for the whole family to go on holiday in the UK together each year : 4,000 for the accommodation, plus trips out and food 2. To pay for both grandchildren to attend a local private school from age : fees understood to be 11,000pa per child. Main Issues 1. Since retirement you have taken more of an interest in the stockmarket 2. Kylie and Stuart [daughter and son-in-law] earn just enough to make ends meet 3. You would like to retain control of your assets to secure your own income needs first before paying for holidays and school fees 4. You have up to date wills, leaving everything to each other, then all to Kylie 5. Kylie will ensure your assets are used for the grandchildren s education 6. Both are in fair health, with only a few minor ailments over the years Other Issues 1. No interest on cash; no return on premium bonds since Reasons for VCT? 3. Meeting objectives on first death 4. Effects of ill health / long-term care 5. Inheritance tax implications ASSUMPTIONS Inflation : 3.0% Above the Bank of England predicted rate and the recent average for both CPI and RPI, but more realistic : several items of normal expenditure increase by more than the official rate. Savings Interest : 2.5% Generally behind inflation over the long term. Investment Growth : [before charges] Gilts 3.5% : risk-free return based on redemption yields Index-Linked Gilts 4% : 0.5% over inflation Corporate Bonds 4.5% : Typically 1% over gilts, allowing for extra credit risk Equities 7.5% : Based on historic equity risk premium of 4%, the difference between the return expected on equities and the risk-free rate on gilts. Property Funds 5.0% : MSCI Property Funds Index suggests 2.1% over inflation Life Expectancy : 100 Higher than the life expectancy of years for a male of 70 and for a female of 60 [ONS Life Expectancy Calculator] but more cautious in calculating how long capital is needed. School Fees : 5% 2% above inflation Average increases 21% over past 5 years [recent Lloyds Bank Survey] 1

2 Pensions Increase Occupational : 3% - with inflation State pensions : 2.5% - based on triple lock guarantee [highest of CPI/earnings/2.5%] Other : 1. 1,000pa for holiday outings etc, 2. Kylie and Stuart won t be able to contribute to holidays or education 3. Expenditure reduces to 70% on first death 4. No ethical, social or environmental restrictions on your investments 5. Taxation rates remain unchanged, with allowances and exemptions increasing with inflation. INVESTMENT RISK [Subject to full risk profile] You describe yourselves as having moderately risky attitude to risk, happy to invest up to 65% in equities once your annual expenditure is secure. Typical investors with this profile would feel uncomfortable if their investments fell more than 25%. Types of Investment Risk 1. Absolute risk : your investment may be less in value when you sell it than when you bought it. 2. Market risk : the risk within a geographical sector or market sector. International investments also carry the risk of currency fluctuations. 3. Specific risk : an individual part of your investment may fall in value. 4. Comparative risk : an asset may rise or fall in value compared to other assets, or to inflation. 5. Inflation risk : The possibility that the purchasing power of assets will be eroded. There are 3 aspects of risk tolerance : Risk required : the investment risk you need to take in order to have a reasonable chance of reaching your objective Risk attitude : your willingness to take a certain risk in return for potential rewards Risk capacity : the extent to which you could sustain a market decline without affecting your lifestyle / plan FINANCIAL POSITION Net Worth 18/07/2016 Excluding property and personal effects [not provided] : Asset Dennis Margaret Joint Total Cash 5,000 5,000 Premium Bonds 10,000 10,000 20,000 Albion VCT ,575 Investment Trusts 39, ,125 Total Assets 77,700 Liabilities Net Worth 55,575 17,125 5,000 77,700 2

3 Net Income [From pensions only, without dividends] Dennis : 17,400 Margaret : 19,640 Total : 37,040 Less expenditure : 25,000 Disposable income : 12, If last year s dividends are repeated you would also receive 500 [Albion], 1560 [City Of London], and 100 [Schroders]. 2. The VCT is paid tax-free; the others fall within your 5,000 dividend allowance Cashflow 1. You are unlikely to need your capital for normal expenditure 2. The total outlay on education would be 249,823, with first fees required in September 2017 and the last ones in Double fees will be paid from If 5,000 is used for holidays you have 7040 left for education 5. Based on the above assumptions and risk profile, your capital would run out at Dennis age 79 : it would start to rebuild from age 89 when you again have surplus income 6. To prevent this, you would need an overall return of 8.08% on capital INVESTMENT TRUSTS The sole purpose of investment trusts is to invest shareholders money in the shares of other companies : they provide access to professional investment management, spreading risk by holding a diversified portfolio of shares. Several factors distinguish them from open-ended funds [OEICs, unit trusts] : 1. They are companies, with shares listed on the London Stock Exchange, and a board of directors responsible for looking after the best interests of shareholders and investors. 2. They are closed-ended : they have a finite number of shares, so are unaffected when investors wish to buy or sell. 3. Trust shares often trade at a discount, i.e. a lower price than the value of their underlying assets [the Net Asset Value, NAV], if demand is low. Dividends, however, are based on the full NAV. 4. They may also trade at a higher price than NAV [ premium ], if demand is high. 5. Gearing : Trusts can borrow to buy more assets, enabling them to maximise buying opportunities without having to attract new money from investors. Gearing increases a fund s potential returns when markets are favourable, but can magnify the risk in a downturn. 3

4 VCTs 6. Dividends : Trusts can retain up to 15% of their income, and can pay dividends from capital growth : they can therefore continue paying dividends during difficult times, and several trusts have consistently increased dividends annually. 1. A VCT is also a company, listed on the London Stock Exchange and approved by HMRC. 2. They invest in mainly small, private start-ups or developing companies with high growth potential needing financial support 3. Income tax relief of 30% is available on the purchase of newly-issued qualifying shares [20% when Dennis invested]. 4. There is no income tax on dividends, and no capital gains tax [CGT] on disposal; losses can t be offset against other gains EXISTING INVESTMENTS Albion Development VCT 1. Launched Invests in lower risk, asset-backed investments, and a smaller number of higher risk companies with greater growth prospects 3. Focuses on small and new companies, which are high risk. 4. With 20% tax relief, the net investment would have been 8, Grown 47.3% over 5 years to June Discount: -5.8% 7. Total dividends from outset 47.75p per share : you would therefore have received 4775 tax-free altogether. 8. Current value 6575 plus 4775 dividends = 11,350, return of 1350 on initial investment 9. No borrowings 10. Normal charge : 2.76%pa City of London 1. Invests in mainly UK-listed equities (86.6%) when purchased / now per share, giving a total gain of 29, Premium to NAV : 1.2% 4. Current gearing : 8% 5. Grown 84% over 5 years to June Long history of dividend increases 7. On-going charges [OCF] : 0.42% 8. Premium : 1.2% Schroder Japan Growth 1. Share price now : initial investment 7576 / current value Current gearing : 13% 3. Dividend only paid in last 3 years 4. Discount : -1.2% 5. On-going charges [OCF]: 1.09% Portfolio Overview 1. The asset allocation does not meet your risk profile 4

5 % of your assets is in equities, which is just above your tolerance level. 3. However there are only 2 asset classes equities and cash which increases both absolute and market risk as you are not diversified into other asset classes such as property or fixed interest. 4. The equities are mainly in just 2 geographical areas, UK and Japan, which again increases market risk. 5. The VCT is high risk, while Japanese equities are regarded as higher risk - but together they constitute over 17% of your portfolio 6. The Schroder trust is also volatile : for instance, in one 12-month period it rose 32% but in the next fell to -3.4% 7. You are not getting any return on almost one-third of your holdings [deposit, premium bonds]. 8. Inflation has reduced the buying power of the 10k premium bond investment to c Although the dividends may seem attractive, you are heavily reliant on one source [City of London]; while the capital value of the other source [VCT] has fallen c34% 10. The new dividend allowance makes the tax-free nature of VCT dividends less important 11. In summary : Dennis has 18% Defensive / 82% Growth assets; Margaret has 58% Defensive / 42% Growth Valuations - 30 th June 2016 Stock Shares Discount/ Premium OCF % Yield % Purchase Price p Value Gain VCT 10, % , City of 10, % , London Schroder 5, % OPTIONS FOR PAYING FOR HOLIDAYS & EDUCATION From Income You could use surplus income for holidays and school fees, supplemented by withdrawals from capital. 1. The first fees are required in September 2017, when 5051 would be needed from savings 2. From 2017 to 2027 you would need a total 178,900 from capital to supplement your net income. 3. From 2028 you again have surplus income 5

6 Invest Surplus Income You could use existing savings and investments, and invest surplus income to build up capital for the later years of education. 1. Ideally you would save for at least 5 years before drawing on this fund 2. This gives the advantage of pound cost averaging : buying more units in the chosen funds if prices fall. 3. However, it also means depleting your existing capital early with no certainty of replacing it. 6

7 RECOMMENDATIONS Investments Existing 1. Encash premium bonds : in view of your objectives, you cannot afford to have investments that don t generate a return ,000 to go into a 1-year fixed account, to make up the income shortfall for the first 2-3 years of education costs; the rest added to your investment portfolio 3. Move your joint deposit to an easy-access interest-paying account, to keep as a contingency fund. Any interest on these accounts would be within the savings allowance of 1,000, so no tax payable. 4. Keep the VCT : although it is high risk, selling could be too costly - The share price is already less than the NAV [ discount ] There is no active trade in secondary VCT shares, so you may be offered even less Albion don t have a buy-back service : you would have to sell through a broker and incur further costs 5. [Subject to your agreement] : Divide the City Of London shares equally, to use both CGT allowances 6. Reduce City of London to 15,000 [ 7,500 each] : while it is tempting to retain an investment with strong performance, it forms too high a proportion of your portfolio and you will sell at a higher value than the NAV [ premium ]. No CGT liability as this would be within your annual allowance 7. Sell Schroder Japan : it is worth incurring the small loss to allow diversification across other international markets. Revised Portfolio - 62,700 Divided into two mirror portfolios [except VCT] : Asset Allocation Anticipated Return % Fixed Interest Gilts Index-Linked Gilts UK Corporate Bond UK Equities [35%] UK Large / Med* 24 - UK Small ** 11 Equities Global Commodities Property Total *City Of London **VCT ***Schroder 7

8 Notes 1. We would use investment trusts for all sectors - except fixed interest, which would be index-tracking funds. 2. Rather than buy individual funds, incurring extra trading costs, international equities would be better covered by a global investment trust 3. Wherever possible we would choose trusts currently trading at a discount, and with low or no gearing 4. The first 15,240 each would be used for this year s ISA allowances, beginning with fixed interest funds. 5. After we could put the remaining funds into your ISA by a Bed & ISA transaction, so the whole portfolio will be free of CGT and income tax. Capacity For Loss 1. If your portfolio fell by 18%, and never recovered, you would not be able to meet the full education objective [see below about holidays] 2. During the past 20 years, the largest fall in similar portfolios was 24.4%, recovering after 26 months. This should be within your comfort level Charges Dealing spread : the difference between buying and selling prices, typically 5% Stamp duty of 0.5% on investment trusts Annual charges approximately 0.45%, reducing anticipated overall return to 6.08% Trading cost c per fund Platform charges [fixed] paid from a cash float without affecting returns Financial planner fees invoiced directly. MEETING OBJECTIVES 1. By keeping enough savings to supplement your income for the first 3-4 years, you can postpone withdrawals from your medium- to longer-term investments. 2. The revised cash-flow shows you are still likely to run out of capital by Dennis age 79. To avoid this you would need additional income of 3930 from age [after which your income again exceeds expenditure]. This would mean either omitting the family holiday for those years or finding reductions in normal expenditure OTHER MATTERS 1. If either of you had died yesterday, the survivor could not maintain your education objectives. Your capital would be fully depleted after 6 years [Dennis death] and 5 years [Margaret s]; though you could still pay for the family holidays. You could consider decreasing term insurance to cover the fees 2. Lasting Power Of Attorney, in case either of you became mentally incapacitated and unable to make reasoned decisions about health and finances 8

9 IMPLEMENTATION Within 1 month Clients Agree overall strategy Decide education / holiday priority for middle years Planner Life cover quotation Select new funds Within 2 months Client / Planner Encash premium bonds New cash deposit Notice accounts Investment trust sales New fund purchases Life cover if agreed With Solicitor Lasting Power of Attorney REVIEWS Instigated by Financial Planner : Annual [June?] Following school year requirements Risk profile Investment performance Ensure asset allocation still appropriate 9