11 September 2011

Pension or ISA?

Let's say you have a sum of money from a generous aunt to invest. Or perhaps you have simply managed to build up some spare cash from your income. What is the best thing to do with it - add it to a pension plan or put it into this year's ISA?

Both are tax-efficient in their own way: Pensions on the way in - reclaiming the tax you will have already paid on that amount, and ISAs on the way out - being free of Income Tax or Capital Gains Tax on any income or growth.

Both have restrictions, though. There are limits to pension contributions, and you can (in most cases) only take the majority of it out as an income after age 55 (which will be taxable), rather than as a lump sum. The main exception (other than dying!) is if you have other secure pension income of at least £20,000 pa which gives some more options.

ISA restrictions are simply that there is an annual allowance for contributions.

So the answer is that it depends. If you are close to retiring and improving your potential income in retirement is more important than having a lump sum to surrender, then go for a pension contribution. For more flexibility an ISA contribution may be more appropriate for you.

6 September 2011

The Euro Struggles On

I continue to be amazed at the naivety in Euroland (see my July post about why the Euro will never reliably work in the current format).

Politicians don't yet see the magnitude of the problem, it seems to me. There is a classic investment cycle which tracks investor attitudes, and one of the stages is "Denial" which is pretty much where politicians are. There will have to be some more pain before there is serious action (like allowing a country to (properly) default on its debt.

In the meantime investors should avoid dodgy countries, and banks with exposure to them. Not very easy to find out, though. Personally, I'll just avoid banks!

Apart from a default or two (like Iceland did), economic growth would be a way out, but there doesn't seem to be too much of that around the world. Otherwise inflation is the economist's friend (but not the investor's).

What is NOT possible is devaluation - at least not in a selective way. Whoever thought it could work??!!

2 September 2011

Hedging and Ice Cream

Hedging your investments has long been possible for professional investors. But there are also possibilities for retail investors, too.

What are we talking about? Normally, if an investment goes down in value the investor will lose out - on paper at least. But if you can find an investment which goes up when something else goes down, you can (at least) reduce your loss.

Here's a simple example (although you might say it's more about diversification than hedging, but it illustrates the point)... If you invest in an ice cream manufacturer you will do well on sunny days but badly on wet days. So why not "hedge" your investment by also investing in an umbrella manufacturer. That way, one part of your portfolio increases in value whatever the weather!

Professional investors - including discretionary managers who look after retail clients' money - will hedge by doing things like buying and selling "options". That way they profit if an index like the FTSE 100 goes down, reducing the overall loss in the portfolio.

But you can also make use of structured products to do something similar. By picking products which give different returns for different outcomes (the FTSE goes up a lot, up a bit, down a bit, etc.) you can secure some growth whatever the markets do (within certain constraints).

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