In our new weekly series, readers can email in with any question about their finances to be answered by our expert, Charlotte Ransom. Charlotte has 30 years experience being a financial adviser and working for investment banks, including 10 years as a partner at Goldman Sachs. She cofounded Netwealth, which specialises in low-cost financial advice. If you have a question for her, email us at [email protected].
This week’s question: I have just inherited £58,000 after the death of my lovely father. He was a pretty successful businessman and often said that the best money he ever made was in the homes he bought. I’m tempted to put the money towards a buy-to-let – an investment he would approve of. The idea of having an extra income is appealing, but I’m not sure I want the hassle and I’m also reading about lots of landlords selling up. I’m in my mid-forties, have two children in their early teens and a busy job. What I want most of all is to not put the money somewhere too risky as the idea of losing all his money would be heartbreaking, but at the same time having a bit extra to help pay for the kids’ university fees or flat deposits would be amazing. Can you advise what I should do with it? GG, Harrogate.
Charlotte’s answer: Property has certainly been a great investment for many of your father’s generation with prices rising significantly over the past few decades. However, while we will all be familiar with the phrase “as safe as houses”, you will want to think about how the characteristics of a buy-to-let investment line up with your objectives for this money.
One of the main benefits of buy-to-let investments is the ability to have a mortgage and gain leverage. What this means is you might purchase a property with, say, a 20 per cent mortgage loan, instead of paying for the whole property. You can use this borrowing to increase the return on your money (which is known as leverage) assuming property prices rise.
However, you pay interest on the mortgage from your rent. When interest rates were low this didn’t matter too much, but now that rates are rising (with some predicting they could approach 5 per cent this year) the cost of the mortgage has gone up and this could seriously dent your rental income.
On the upside, the monthly income from a buy-to-let can be quite attractive and, as many landlords have exited the market and with demand continuing to outstrip supply, rents have been well supported. However, if you then want to use a chunk of the capital to help with a flat deposit for a child, you can’t simply sell a part of the property to fund this. Instead, you would probably have to sell the property, which can take time and be costly.
With interest rates on the rise, and in line with your desire for low risk, it could be worth thinking about cash. Interest rate rises have had a positive impact on the level of return that you can make on it. Although banks haven’t always been quick to pass this on, if you hunt around you should be able to find accounts paying over 3 per cent on instant access and over 4.5 per cent for a one-year fixed deposit. Given you have £58,000 from your inheritance, this amount falls within the FSCS deposit protection of £85,000, so your funds will be protected by the Government, if anything were to happen to the bank you deposit with.
Lower-risk investment portfolios are similarly looking more attractive currently than in recent years. Although more risk is involved than with cash, there should also be more return to be achieved. If there is some time (five years-plus) before your children leave for university or will need help with flat deposits, you may feel comfortable taking a little more risk, since you shouldn’t be a forced seller during short-term market fluctuations.
However, bear in mind that fluctuations in value will occur over time. You’ve said the idea of losing all of this money would be heartbreaking and with a well-diversified portfolio – i.e. investments spread across a broad range of markets and asset classes, such as shares in US and UK companies, and European corporate – such an extreme outcome should not be a risk.
Exchange Traded Funds (ETFs) are a good example of diversified funds and are easy to access. Nevertheless, you do need to be willing to accept the ride. A portfolio of equities could easily fall 10 per cent in any given year on the way to generating good long-term growth. If you are too uncomfortable to ride out the falls and sell out, you run the risk of locking in a short-term loss and losing money.
There are lots of well diversified funds you could invest in and it’s important to consider fees to make sure your returns are not eaten up by overly high fees from the platform or fund manager. This is often a bigger risk than investors realise. For example, if you invest £100,000, assume growth of 6 per cent a year and pay 1 per cent in fees each year, your pot would have grown to £162,889 after 10 years. By paying 2 per cent in fees yearly (1 per cent more), with all else being equal, your pot would be worth £148,024 – almost £15,000 less.
Whatever you choose to do it’s always a good idea to be as tax efficient as possible. With a property investment there is no easy way to do this and the tax rules are not as favourable as they once were. For cash and investments, one simple option is an ISA account where all of the returns you make are tax free. Be sceptical of anyone that wants to charge you a fee to set up an ISA or to contribute funds since it should be a free wrapper to help you be tax efficient.
Your annual ISA allowance is £20,000, so you couldn’t put all of the money into an ISA in one go but could build this up over time. As you’ve said, you would like to help your children, you could also consider gifting the money to them now and investing it in a Junior ISA (JISA). This can be a great way to get your children engaged with money and thinking about investments, a skill that will stand them in good stead for the rest of their lives.
The JISA allowance is £9,000 per year and remember that once money is put into a JISA it belongs to your child. They can’t access the money until they turn 18 which might provide some comfort, although 18 is still young and you may worry about them using it for something your father wouldn’t have approved of.
To protect against this, I suggest being really clear with them about where the money has come from and what the purpose of it is. I’ve found that making young adults take some responsibility for these type of investments and helping them to understand that their decisions have consequences can be just as powerful as a legal arrangement.
Charlotte Ransom is CEO of Netwealth
