Making the right investment choice is an important part of Financial Planning.
Regular readers of our blog will know that we constantly “bang-on” about the need to link investment decisions and Financial Planning goals together.
We also constantly point out the need to invest according to your own attitude towards risk, reward and volatility and also your personal capacity to accept a potential loss.
In this blog I want to add three further factors into the mix – those of taxation, costs and inflation.
The adage “don’t let the tax tail wag the investment dog” is a good one. But we shouldn’t ignore taxation; it is after all a drag on investment returns.
Always consider the investment results you achieve in light of the net return after tax.
Of course some investments come with the benefit of a tax wrapper. A good example would be the Individual Savings Account or ISA.
The tax wrapper here protects any investment gain from Capital Gains Tax.
Most of the income generated by the underlying investment funds of an ISA is free from income tax (UK equity dividend income is taxed at 10% and the ISA manager and the ISA owner cannot reclaim this) and any income being paid from the ISA is income tax free.
Other investments however may well be subject to income tax and/or capital gains tax and these need to be taken into account and products and tax wrappers selected which are most appropriate for the particular investor.
Costs or charges are another form of drag on investment returns. The good news here is that we see overall charges for financial products beginning to fall.
We believe that this has a lot to do with both the transparent nature of modern investment products and greater competition emerging, particularly the growth of self-directed investment platforms available online.
The third drag on investments is that of inflation. This may not be something that we notice on a day by day basis but has an important impact over time.
Put simply inflation reduces the purchasing power of the £1 in your pocket (or the £1 in your investment fund) over time. The nominal value may be the same but £1 in 1980 purchased far more than it does in 2013 thanks to inflation.
So the thing to do is to measure investment returns net of all these “drags”; net of taxation, net of charges and net of inflation (something called the real return).
The net figure is then the true representation of how well or badly your investment has actually performed.
Photo credit: Flickr/bikesandwich
