We are living in paradoxical times when it comes to personal finance and investment. On the one hand, MT readers have never been so well off.
The economy has been growing for more than a decade and house prices have doubled since 1999, executives have enjoyed bigger pay rises than more junior staff, and three-quarters of a million Britons now have more than £200,000 saved, excluding their homes and pensions. 'Clearly, more people have never had it so good, and the wealthy are doing particularly well,' says Martin Ellis, chief economist of the Halifax, Britain's biggest mortgage lender.
But deciding what to do with our burgeoning surplus cash is increasingly difficult. The old investment standbys aren't looking as certain as they once did. Property has done well for five years, but now looks set to plateau or even nosedive. Stock market performance remains lacklustre after the boom-and-bust of the '90s. The tax squeeze gets ever tighter, and looming over all of us is the question of what, if anything, our pensions will be worth when we come to draw them.
In an effort to clarify this confused and confusing picture, MT brings you MT Wealth, a new quarterly guide. As well as steering you through the complexities of saving and investing the hard-earned cash that your professional success has brought you, we'll be suggesting alternative investment ideas that have fun value as well as potential for growth.
This first instalment provides a broad overview of the basic pillars of personal finance - property, pensions, maximising investment returns and minimising tax - as well as tips for taking a punt on the wine market.
Will you need to survive a crash?
Making a quick £100,000 from property is unlikely to remain as easy as it has been. Nor will so many people be making more money from the rising value of their home than from working.
You would have struggled to find start-of-2005 forecasts for a return of the property boom. Last year's slowing market firmly positioned the debate between crash and soft landing: prices plunging or going nowhere fast.
John Calverley, chief economist of American Express Bank, thinks it will take a recession to trigger a crash, but that in the interim prices will remain pretty static. 'People are right to feel uncertain about the long-term value of their house,' he says. His book Bubbles and How to Survive Them argues that UK house prices are over-inflated and face a 30% fall.
A drop like that might take away only two years of boom-time price growth, but that would require home values to recover 50% to get back to their peak, and that recovery might take many years. Essentially, property is unlikely to continue to create the wealth that people have come to expect, undermining the case for buy-to-let and property as a form of retirement funding.
In the soft-landing corner, Halifax's Ellis describes crash talk as scaremongering.
'House prices are only a big issue if you've got to sell up. And over the long term prices have always increased.' And property is supposed to be a long-term investment, after all.
If prices crash, people who bought just before the market peak without much equity might find themselves owing more than their property is worth - so-called negative equity. That could tie them to a property that they are unable to sell without coughing up the shortfall. Buy-to-let empires built on remortgaging profits from one property to buy another could also grind to a halt.
Yet holding less property is not a choice for most homeowners. Selling up and renting ahead of a feared crash might be too much of an upheaval, or might not suit individual circumstances - in which case there is little choice but to sit out any storm that rolls in.
It's possible to hedge against falling house prices using spread-betting, but this is a specialist and risky investment, for the brave and/or clued-up only.
Remortgaging or paying down your home loan at least offer the consolation of reducing the ongoing cost. Paying down your mortgage is also a good tax-free investment - on a loan charging 6%, it is the after-tax equivalent of the long forgotten 10% savings account.
You might have to change your plans
For many high earners in traditional final-salary schemes, 'pensions have been things they haven't needed to worry about', says Chris Haines, head of wealth management at Bank of Scotland. Now they are the biggest financial concern of BoS's £75,000-plus client base.
The decline of employer-provided pensions - three million jobs have been switched from final-salary to money-purchase schemes so far - will increasingly hit senior staff. With company contributions halving on average, many money-purchase pensions will be lower, and dependent on uncertain investment performance rather than salary and length of service.
High earners switching jobs are generally offered only a money-purchase pension, according to Peter Boreham, head of executive rewards at Hay Group. 'I often read that there's one rule for executives and another for staff,' he says. 'That's actually very rarely the case.'
The collapse of Equitable Life has also hit the pension of many high earners: it was the biggest provider of top-up AVC pension plans, specialising in personal plans for the wealthy.
Some high earners will be wondering whether they are saving enough. Last year's Turner Report on pensions warned that although middle Britain faced the worst of the pensions crisis, a million people earning more than £40,000 are heading for pensions of less than half their pre-retirement earnings.
Of course, many high earners have other savings to fill the gap. But the 'pensions simplification' changes due next April will also provide attractive tax-efficient saving opportunities, say advisers.
From so-called 'A-Day' (April 5, 2006), buy-to-let property and holiday homes can be bought through a personal pension, so allowing rent and profits to roll up tax-free. This will no doubt be popular, although there are fears that people will become even more skewed towards the fortunes of property at exactly the wrong time. 'Stocks are reasonably valued, property is overvalued,' cautions Calverley at Amex.
Many high earners will also be able to put much more into a pension (up to 100% of earnings each year, capped at £215,000), while slashing their income tax bills for the year. 'Expect to see a lot of bonuses go into pensions,' says BoS's Haines.
The introduction of a new 'lifetime allowance' or limit on pension saving will also affect anyone who thinks their pension fund will top £1.5 million or expects to receive a pension of £75,000 or more a year. With the threat of a lifetime allowance charge of 55% on the surplus, this complex area is worth getting professional advice on as soon as possible.
TAX-BUSTING INVESTMENTS</Paragraph[xyz]Individual savings accounts (ISAs): Invest £7,000 a year tax-free,
£3,000 of which can be in cash
Venture capital trusts (VCTs): Income tax relief of 40% on investments
up to £200,000 a year
Pension carry-back: Up to 40% tax relief on personal pension
contributions (within set limits) to reduce tax in previous year
Pensions (from April 2006): A maximum of 40% tax relief on all
contributions up to £215,000 from annual earnings
Stakeholder pensions: Basic-rate tax relief on gross contributions up to
£3,600 for non-working spouses
Capital gains tax: No tax on up to £8,200 of realised investment
Inheritance tax: Give away up to £3,000 a year free of inheritance
Gift aid: Charities may reclaim basic-rate tax relief on donations;
higher rate taxpayers can reclaim 18%
Balance risks and rewards
Despite positive returns in 2003 and 2004, many investors are sitting on big losses from the halving of the stock market's value in the dot.com collapse. Looking ahead, the basic investment choices might seem unpalatable: low deposit rates, little better than single-figure equity returns - with the real possibility of losses - or property, which could be facing a crash. So how might investors improve returns?
The growing popularity of hedge funds is understandable, given their focus on 'absolute returns' - aiming to make money even if markets fall.
A hedge fund can invest in whatever it likes, and investment strategies and returns vary widely. But management costs are generally high and, in contrast to the case with traditional funds, you could lose all your money. Sensible advice is to invest in more than one hedge fund, but never invest more than a small part of your portfolio.
Venture capital and private equity also hold out the possibility of high returns, but again costs are often high. And there have been concerns about too much money chasing a shortage of good business opportunities.
In a low-inflation world, say experts, investors need to get used to generally lower returns. In times when it's harder to make money, having a more disciplined approach can also help. High earners can easily accumulate an unwieldy range of investment holdings or a scary over-exposure to one asset type or a corporate investment. Advisers say it's important to review investment holdings regularly against overall financial objectives - early retirement, repaying the mortgage and so on. Getting the right spread of investments will also reduce unnecessary risks.
Consider whether you have the time, interest or skill to run your own portfolio. The internet has cut the costs of DIY investing and increased information flow. Time-poor high earners will find no shortage of wealth management services chasing their business. Services vary widely, but the idea is to offer a one-stop shop for investment and financial planning needs, often including 'private banking' and with a focus on personalised service for 'almost CFOs to high net worth individuals', as Capgemini analyst Richard Thornton puts it.
Some wealth managers team up with auction houses and property consultants.
'Wealth managers are trying to lock clients in,' explains Thornton. But getting the right match is key: even high earners may blanch at fees that can run into thousands of pounds a year. 'A busy executive may see the advantage. But it can be difficult to offer all the services people want at the prices they are prepared to pay,' he warns.
Keep it to a minimum
House prices may have doubled since 1999, but Gordon Brown has taken a bigger share of that boom with a 400% increase in stamp duty over his time as Chancellor. Similar grumbles are made about the rising inheritance tax take, with increased house prices alone putting up to two million more families in the tax net, according to Halifax.
Both ISAs and pension funds have also lost income tax perks in recent years. Few expect the tax squeeze on wealth to ease. Although experts warn about not allowing tax to dictate investment choice, tax-efficiency can be key in achieving a decent return.
ISAs are still considered the no-brainer for tax-efficient saving and investment, and for couples they allow a meaningful £14,000 a year of capital to be ringfenced. Accountants also recommend making use of the tax allowance of a non-working spouse. This is the last year for personal pension carry-backs, which offer a way to cut higher-rate tax bills while boosting pension savings.
Venture capital trusts (VCTs) offer up to £80,000 of income tax relief (on a maximum £200,000 investment), albeit with relatively high risks.
And from next year, 'pensions simplification' will bring similar tax breaks.
Inheritance tax (IHT), the final fiscal reckoning for increasing numbers of Britons, is worth taking advice about, particularly as the rules will be subject to continuing revision.
Straightforward avoidance techniques include gifts of £3,000 a year and regular payments out of income - for example, into stakeholder pensions for children and grandchildren. But effective use of a couple's nil-rate bands (the £263,000 tax-free limit) as well as trusts can create IHT savings of £100,000 or more.
An investment alternative to savour
Investing in wine has some obvious attractions over putting your money into boring old bonds, pensions and the like. If it goes well, your profits can fund the sampling of an additional vintage or two. And even if it goes badly, there's still pleasure to be had from drinking your investment. But many serious wine investors keep temptation at bay by storing their wine holdings in controlled conditions in a bonded warehouse, thus avoiding paying VAT as well as duty.
You can buy young wines en primeur before bottling, or by the case, but either way investment wines are essentially the finest red Bordeaux, normally vintages from the past 20 years. A single case of investment-quality wine - for example, a first-growth Chateau Haut Brion 1990 - might set you back more than £2,000, although other wines can be had for just a few hundred pounds a case.
Most demand for wine investment comes from the US and the weak dollar of the past couple of years has held the market back, with some prices falling, according to James Miles, a director of Liv-ex, the London International Vintners Exchange, a trading service for fine wine merchants (www.liv-ex.com). The American boycott of things French has been another negative influence.
Even so, Liv-ex's Claret Chip index of 33 top Bordeaux vintages was up 10% last year in sterling terms, ahead of the FTSE-100 index - underlining the oft-given advice: go for quality.
Wine investments also stand to benefit from increasing scarcity as stocks of a vintage are drunk over. 'The exciting thing,' says Miles, 'is that this investment can't be replicated.'
Potential wine investors should also be careful who they trust. Over the past decade, British buyers have been duped out of up to £200 million on dodgy investment schemes, according to investdrinks.org, a website that encourages sober thinking among investors.
Wine investment is generally unregulated, and even when dealing with reputable merchants, says Miles, investors should always check that they are paying the right price. The internet has made a 'traditionally opaque' market much more transparent, he adds, but the difference between what you can pay for the same wine can vary by 20%.
Ask how a wine has been stored: original cases with bottle labels intact are two good signs; housed in a boilerhouse is a bad sign.
Another advantage of this market is that you should avoid a tax hangover: profits from wine investing are generally free of capital gains tax, as wine is seen as a 'wasting asset'.
BEST OF TIMES ...
House prices have doubled since 1999.
There is an average £114,000 of equity in every British property.
The UK has enjoyed 12 years of uninterrupted economic growth, the
longest period on record.
The number of millionaires in the UK has doubled to 425,000 since 2001.
There are 747,000 people in the UK with £200,000 or more
(excluding pensions and housing) in savings and investments.
Senior corporate executives (below board level) have enjoyed a 25%
five-year total increase in pay and bonuses, double that of more junior
WORST OF TIMES ...
The number of higher-rate taxpayers has risen 50% since 1997, to 3.3
The UK stock market fell by 53% between 1999 and 2003.
Three million employees have been switched from final-salary to
money-purchase pensions, mainly since 2000.
There is a £27 billion annual shortfall in pensions saving by
The average ratio of house prices to incomes stands at an all-time high
Stamp duty on house purchases in 2004 raised £4 billion, a 400%
increase since 1997-98.
The number of UK households facing inheritance tax based on property
value alone is 2.4 million.
SOURCES: Halifax, Nationwide, Centre for Economics and Business
Research, Datamonitor, Hay Group, National Association of Pension Funds,
Association of British Insurers.