We invest in many things during our lifetimes. Whether it’s time, money, or experience that we are investing we are always looking for a future outcome. When we invest money it’s important to frame our decisions with what we want our future to look like. It’s helpful to have this approach when we decide how to invest our money.
One decision people often consider is should they purchase a buy-to-let property, or should they build an investment portfolio? It’s not quite a clear-cut decision and a better question would probably be, what mix is right for you? Let’s have a look at some of the important factors you need to think about.
Many of us are familiar with the housing market and have watched our own properties increase in value. A property rented out to reliable tenants can be an excellent source of income. Rents vary hugely across the country, so always do your research.
It is important to remember there will be costs to cover such as general repairs and maintenance, agency fees and insurances. These costs will continue whether you have paying tenants or not. As a landlord you will also be taking on a number of legal obligations which may result in additional costs. You can outsource some of your responsibilities to a managing agent but this will reduce the return.
However, over the last few years the Government has started to reduce the tax efficiency of property investment. Investors will pay an extra 3% Stamp Duty Land Tax when they buy a residential buy-to-let property. They also previously enjoyed Income Tax relief on mortgage interest, but this is also being reduced and will be restricted to 20% from April 2020. When they eventually come to sell their properties, this will now be subject to Capital Gains Tax (CGT) at 18% (within basic rate band) or 28% (higher and additional rate taxpayers) on the gains.
This coupled with rising property prices leading to lower yields makes it harder to find the right property and more expensive to build a diversified portfolio than it was in the past.
Investment portfolios can potentially enable you to spread your investment more widely as you are not having to buy one expensive asset. This means that investors can build up more diversified portfolios to generate income and capital growth. Instead of having their investments just in one town, city, or country they can invest across the globe. Spreading their money into different types of investment such as property, equities, and bonds helps reduce some of the risks.
Whether you choose to build your own portfolio or delegate this to a professional, there will be costs. These relate to the ongoing management of the funds, ensuring that the overall mix remains suitable for you, and a structure to hold these safely and securely.
Investors have a choice about how they hold their portfolio. ISAs in particular provide freedom from Capital Gains Tax and Income Tax; you can add £20,000 to your ISA each year.
Income generated by a portfolio is taxed differently to property. For investments held outside an ISA, the first £2,000 of dividends are tax free and the subsequent rates (7.5%, 32.5% and 38.1%) compare favourably with the main rates of Income Tax (20%, 40% and 45%). Some of the income generated by a portfolio will be taxed as Interest and most investors will have a tax-free Personal Savings Allowance of up to £1,000. The respective rates of Capital Gains Tax are also lower at 10% and 20%.
Perhaps the biggest advantage of using an investment portfolio approach is liquidity. It isn’t possible to dip in to the capital value of a buy-to-let property without selling the whole thing. In comparison you can sell part of an investment portfolio if you need access to capital. As well as the practical and tax considerations, it is normally a lot quicker to sell an investment than a property.
|Investments held within an ISA are free of Capital Gains & Income Tax. You can add £20,000 to your ISA each year.
||You pay an extra 3% Stamp Duty surcharge on additional properties.
|Investments held outside an ISA are subject to Capital Gains Tax at either 10% (Basic rate) or 20% (Higher & Additional rate).
||Capital Gains Tax is calculated at a higher rate – 18% (Basic rate) or 28% (Higher & Additional rate).
|You can access your money quickly if your circumstances change.
||From April 2020, tax relief on mortgage interest will be restricted to the Basic rate of Income Tax (currently 20%).
So what about you?
As with many aspects of life and financial planning there is no easy answer. You should consider what you need this money to do for you. For most people our money is there to serve our lifestyles (current or future). If we start to find managing the money takes away from this then we probably need to reassess our decision.
If you are likely to need to dip into it then an investment portfolio might be more attractive. Delegating responsibility about where to deploy your money and the day-to-day management may also become desirable as how we want to spend our time changes.