Do you also pay tax on the interest?
That's stopped me from doing the same, it's possible to get an ISA with 4% tax free but the deposit is limited to £20k I think.
I'm waiting for an appointment with a financial advisor through the union but he seems to have gone awol.
You are limited to £20k
per year that you can put into an ISA. This makes it an excellent long-term savings vehicle, because (a) £20k per year per person is a lot(!) and (b) there is no capital gains tax and no tax on income, which means if you manage to get a 100% return on £20k over 10 years, none of this is taxed.
That means it is a real waste of the vehicle to use it for low-return options. Yes, you won't be taxed on the 4%, but you don't get taxed on £1000 in interest per year anyway, so getting £800 tax free on £20,000 isn't much to get excited about. You should think of the ISA like a pension -- the aim is to not take the money back out after you've put it in, until you reach the point at which you become a net spender instead of a net saver. That means there's no advantage to minimising the volatility of return, it's about maximising the expected return. Basically, if you're going to hold any equity funds, the ISA is the place you want to do it.
**
I have always hesitated to describe my strategy, because (a) it feels very gauche; (b) I don't want to offer it as a template for anyone else; these things come down to personal opinion; (c) I'm
terrible at second-guessing short-term market trends, so even if my long-term strategy is right, my short-term timing might be horrible; and (d) this is my (current) long-term plan, but I'm not there yet, and I don't want anyone to think this is a recommendation for here and now.
Even so, however, maybe it's helpful to give an idea of the kind of things to think about when considering investments. And a concrete example is always useful for understanding things. So I'll go against my instincts and share, but please take it as a talking point only, not a recommendation.
The ultimate aim is a portfolio that can I can retire off. That means I want it to
(a) produce as high a rate as possible (obviously); but
(b) give me a minimum predictable income; and
(c) minimise the volatility of return within the constraints of (a) and (b).
Some things to consider in order to achieve these aims:
a) All being equal, a worldwide equity index does statistically tend to produce the most reliable maximum return per unit volatility
b) Despite the truth of (a), I am still enough of a fool to think that the right manager
can actually reliably beat the index. YMMV, of course.
c) Exchange rate movements are a massive driver of uncertainty, since my actual expenses are in £. So there is a good reason to be "overweight" in GBP funds
d) Also, an index fund doesn't produce tonnes of its return as actual income. Most of its return comes from increases in its price (i.e. capital gain). This is only realised when you sell some of the fund. Econometrically, that is irrelevant. However, there is a psychological cost to relying on selling things for your income -- price is volatile and nobody likes being forced to sell on a downswing. Also, it's a bit tiring to have to keep selling chunks of fund. As such, I do actually want some of my portfolio to be devoted to funds that pay out a high income.
Those thoughts lead me to want to split the portfolio into seven parts (in the percentages shown in brackets):
1)
UK equity income funds -- these only have UK stocks, which minimises exchange rate risk. They also pay high dividends, which gives a reliable baseline income. (18% of portfolio.)
2)
Worldwide equity income funds -- like the above, but not just UK. This introduces exchange rate risk, but allows diversification to worldwide companies, so tend to produce better overall return. (21% of portfolio.)
3)
Worldwide general equity funds -- these will typically be balanced towards growth stocks as well as income stocks. They thus tend to produce a higher return, but without the reliable income. NB: this is the bucket containing the worldwide index funds. (21%.)
4)
Regional general equity funds -- like the above, but balancing out the UK focus by having funds that specialise in opportunistic situations in the US, Europe or Asia. (7%.)
5)
Specialist equity funds -- I have the belief that some industry sectors are better placed for long-term future growth than others (such as firms seeking to produce green energy and associated infrastructure). (11%.)
6)
Alternative investment income funds -- funds that focus on providing reliable income by investing in things other than equities. Some will be bonds but it also includes things like freeholds and private equity. (5%)
7)
Bond funds -- yes, despite the fact that bonds don't tend to do as well over the long term, it still makes sense to include some element for diversification and income purposes. (16%; note that the other categories will also hold some bonds too).
I have identified between three and seven funds for each category (depending on size of category). My funds in categories 1, 2, 6 and 7 are "distributable" -- I immediately receive any dividends. My funds in categories 3, 4 and 5 are generally "accumulation" -- dividends get reinvested back into the fund..
To give you a feel for what I expect from this portfolio:
- Over the last six years, the total return of this portfolio would have been 7.7% p.a.. This ranged from -4.6% in the worst year up to 19.0% in the best year.
- Based on its current income payout, this portfolio produces an income yield of 3.3% p.a..
The plan is thus to keep the 3.3% income and also sell capital gains worth about 1.2%, giving a total payout of 4.5%. The remaining 3.2% return (i.e. the difference between 4.5% and 7.7%) would then be reinvested to defeat inflation.
