The Main Types of Investments

Which will be most suitable for you will depend on a number of factors including your attitude to risk, expected investment term and your tax situation. The following is an introduction to the main types of investments.

Deposit accounts

These are a means of holding cash securely until you need it.  You are effectively loaning your money to a bank of building society so that they can lend it to others (e.g. to buy a property or run a business).

Advantages – security of capital up to £85,000, a known rate of interest and very suited to providing an emergency fund

Disadvantages – interest rates are very low and cash deposits suffer from the effects of inflation.  They are therefore not useful in increasing the purchasing power of your money.  Whilst you can obtain higher fixed rates you are then tying your money up at a fixed interest rate for a number of years during which interest rates may increase.

Tax treatment – deposit accounts are subject to income tax on the interest, however depositors receive interest gross and do not pay tax on the first £1,000 of interest if a basic rate tax payer, or £500 if a higher rate tax payer.

National Savings & Investments

These are a means of holding cash securely until you need it.  You are effectively loaning your money to the UK Government to enable it to do a myriad of things that governments need to do.

Advantages – security of capital guaranteed by the UK Government, a known rate of interest and very suited to providing an emergency fund.  Some accounts are inflation-linked.  Premium Bonds may make you rich!

Disadvantages – interest rates are very low and fixed interest accounts suffer from the effects of inflation.  They are therefore not useful in increasing the purchasing power of your money unless you are fortunate enough to win £100,000 or more from Premium Bonds.

Tax treatment – some accounts are subject to income tax on the interest, however depositors receive interest gross and do not pay tax on the first £1,000 of interest if a basic rate tax payer, or £500 if a higher rate tax payer.  Other accounts, including premium Bonds, are tax free and these are particularly beneficial to higher rate tax payers.

Individual Savings Account (ISA)

The maximum subscription is £20,000 per individual for tax year 2022/23 so that a married couple/civil partners could currently jointly save £40,000 each year. 

With a wide choice of investments that can underlie an ISA, and its tax efficiency, an ISA is often the first port of call for an investor, particularly for higher rate and additional rate taxpayers and those restricted as to the amount of tax-relievable pension contributions they can make or benefits they can accrue because of existing pension provision.

Advantages

Cash ISAs are effectively tax-free deposit accounts and these are provided by banks, building societies and National Savings & Investments. 

Stocks and Shares ISAs are also tax-free.  The tax on interest on deposits and bonds is automatically reclaimed by the ISA manager for your benefit and dividends are paid gross.  Stocks and shares ISAs also protect investments against capital gains tax.  

Although their name would lead you to believe that these only invest in the stock market they can also invest in other assets such as bonds (i.e. fixed interest funds).  You could also choose from a range of risk-rated investment portfolios (some of which are lower risk) which can be used within a Stocks and Shares ISA.  You should make maximum use of stocks and shares ISAs as the foundation of your investment portfolio.  They are administratively simple in that they do not need to be shown on your tax return.

Lifetime ISAs for those aged 18 to 39 is a longer term tax-free account that receives a government bonus.  As with other ISAs, there will be no tax to pay on any interest, income or capital gains from cash or investments held within a Lifetime ISA.  It will be possible to save up to £4,000 each year in a Lifetime ISA potentially payable until the investor is age 50, although this limit, if used, will form part of the overall annual ISA limit.

The product also benefits from a 25% government bonus on the amount saved, so a maximum of £1,000 each year.  In the first year only, the bonus will be paid at the end of the tax year, after which it will be paid monthly. 

Investors can use their Lifetime ISAs to buy their first home (subject to a maximum price of £450,000).  It can also be used to save for retirement, with tax-free access from age 60.  Money can be accessed at any time, although this incurs a 25% charge unless the saver is in serious ill-health.  This effectively cancels out the government bonus paid on that amount.

Aim ISAs as their name suggests invest in stocks on the Alternative Investment Market (AiM).  Whilst these are very high risk they not only enjoy the benefits of an ISA wrapper but they also qualify for Business Property Relief.  This means that funds held in an Aim ISA are outside of your estate for Inheritance Tax purposes after just two years provided you are still holding the Aim ISA on your death.

Disadvantages

As with all cash deposits Cash ISAs suffer from the effects of inflation.  We do not encourage the majority of investors to use these beyond an emergency fund.

Stocks and Shares ISAs should be viewed as a long term investment. You may get back less than you invested.  The capital is not guaranteed.  Poor investment performance, unsustainable levels of income withdrawals,   adverse sequencing of returns and product/advice charges can have a detrimental effect on the residual fund available.

As Aim ISAs invest in companies listed on AiM rather than the main UK stock markets the risk of loss is very much increased.

Tax Treatment – all types of ISAs are tax free apart from the possibility of inheritance tax which Aim ISAs specifically address.  Furthermore they do not need to be included in an annual tax return.

For further information see the links below

Peer-to-Peer Lending

Peer-to-peer lending accounts are designed to allow people to use their savings to lend to other individuals therefore removing the need for banks and other institutions to be involved. The aim is that those who are willing to lend could get higher returns on their savings than they would if they put their money in a conventional savings account, and in turn the individuals they are lending to could get lower cost loans than they would if they borrowed through a bank.

Advantages – you can normally obtain higher interest rates than those obtainable from bank or building society accounts.  This includes Cash ISAs as well as more traditional deposit accounts.

Disadvantages – peer-to-peer lenders are regulated by the Financial Conduct Authority but are higher risk than deposit accounts as you do not have the £85,000 security of capital provided by the Financial Services Compensation Scheme.

Tax Treatment – interest is taxed in the same way as interest from a deposit account.  ISA accounts operated by peer-to-peer lenders are free of tax in the same way as other ISA accounts.

Unit Trusts

Unit trusts are investments which are suitable for the majority of investors.  A unit trust is a ‘collective investment’ which simply means that you and thousands of other investors pool your money to invest in a particular type of asset and in a particular country or countries.  For example, a UK Equity Fund would be a type of unit trust which will invest in the shares of somewhere between 40 and 120 companies in the UK.  The Fund will have a professional fund manager.  A European Corporate Bond Fund would be a type of unit trust which will loan money at a fixed interest rate to somewhere between 40 and 120 companies in Europe and so on.

You can invest in a portfolio of unit trusts and this allows you to diversify the risk by using different types of assets and different sectors of the world depending on your attitude to risk.  Such portfolios are typically a mix of equities (i.e. stocks and shares), bonds (i.e. fixed interest investments) and cash and sometimes will include property (i.e commercial property) and limited amounts in alternative investments depending on your risk profile.  Using such a portfolio you will typically be investing in many hundreds of individual businesses around the world thus reducing the risk that any particular company failure or regional downturn might make to your portfolio.

Advantages – you can obtain professional fund management for a relatively small investment.  Most unit trusts, apart from those holding property, are liquid so that you can sell units in the fund and receive cleared cash in your bank within two weeks. 

Disadvantages – unit trusts should be viewed as a long term investment. You may get back less than you invested.  The capital is not guaranteed.  Poor investment performance, unsustainable levels of income withdrawals,   adverse sequencing of returns and product/advice charges can have a detrimental effect on the residual fund available.

Tax Treatment – unless they are held in a tax efficient wrapper such as an ISA or a pension unit trusts will potentially involve you in tax in three ways.  Income tax on the dividend income (although for 2022/23 the first £2,000 pa is tax free); income tax on the interest income (although for 2022/23 the first £1,000 pa is tax free for a basic rate tax payer); capital gains tax on withdrawals (although for 2022/23 the first £12,300 of gains is exempt from tax).

For further information see the links below

Open Ended Investment Companies (OEIC)

OEICs are similar in purpose to unit trusts but are structured in such a way as to be acceptable to European investment markets.  As they have a simpler charging structure than unit trusts many UK investment groups use these rather than unit trusts. 

Advantages – you can obtain professional fund management for a relatively small investment.  Most unit trusts, apart from those holding property, are liquid so that you can sell units in the fund and receive cleared cash in your bank within two weeks. 

Disadvantages – OEICs should be viewed as a long term investment. You may get back less than you invested.  The capital is not guaranteed.  Poor investment performance, unsustainable levels of income withdrawals, adverse sequencing of returns and product/advice charges can have a detrimental effect on the residual fund available.

Tax Treatment – OEICs are taxed in the same way as unit trusts.

For further information see the links below

Investment Trusts

Investment Trusts are similar in purpose to unit trusts but there are some distinct differences in the way that they operate.  An investment trust is actually a public limited company (PLC) which is owned by their shareholders – those investors who invest in any of the trusts available and each has a board of directors, independent of the fund manager, looking after shareholders’ interests. 

Unlike unit trusts and OEICs, investment trusts have a fixed number of shares in issue.  This means they do not have money flowing in and out unpredictably, which helps fund managers to plan ahead.

Because shares in an investment trust are listed on the London Stock Exchange their price is affected by supply and demand.  This means that the share price may be different from the total value of the investments it holds (known as the net asset value or NAV).  If you pay less than the NAV for your shares, you are buying at a discount.  If you pay more, you are buying at a premium.  Changes in the difference between the NAV and the share price can magnify the gains or losses on your investment.    

Advantages – you can obtain professional fund management for a relatively small investment. As an investor in an investment trust you are able to attend the Annual General Meeting. 

Disadvantages – investment trusts have the ability to borrow additional money to invest, known as gearing.  This can enhance potential investment returns but gearing can also increase the investment risk of a trust, so whilst gearing can boost gains, it can also magnify losses.

Tax Treatment – investment trusts are taxed in the same way as unit trusts.

For further information see the links below

Ethical Investments

You can have the option of an ethical fund when considering a wide range of investment products.

‘Ethical’, ‘green’, ‘environmental’ and ‘socially responsible’ funds tend to be referred to under the generic name of ethical funds. There are, however, differences which can be very important for particular investors. 

Advantages – you can invest your money in line with your beliefs about the environment, the slave trade, armaments, pornography, human rights, alcohol, tobacco, animal welfare etc.

Disadvantages – you could receive lower returns because you are, by choice, investing in a narrower range of companies and the ones that are omitted may produce the best returns.  Many very large companies are so diverse in their trading that they may find themselves omitted by the fund manager during the screening process.  Having a portfolio of somewhat smaller companies will tend to underperform in times when markets are falling or investors are generally looking for safety.

Tax Treatment – this will depend on the investment product that you are using.

For further information see the links below

Structured Products

Structured products are pre-packaged investments which are based on specialist financial instruments called derivatives, such as single security, a basket of securities, options, indices, commodities, debt issuances, and/or foreign currencies.  Such investments have fixed terms of three years or more (the majority are five or six years).

Structured deposits are the lowest risk structured products as they are always capital protected at maturity and invest in cash deposits, with the interest payments linked to the performance of an underlying asset, often the FTSE 100. 

Advantages – for funds that you are prepared to lock away for three or five years a structured deposit can provide higher returns than deposit accounts.  You capital is protected in the same way as capital held in a deposit account.

Disadvantages – the returns may not look particularly attractive after inflation is taken into account.

Tax Treatment – the gain will be taxed under income tax as interest and with others it will be taxed under the more favourable capital gains tax regime.

Structured investments with capital protected typically offer a percentage of the growth in an index (sometimes capped) whilst offering 100% capital protection at maturity. 

Advantages – a structured investment with capital protected allows you to gain some benefit from the increase in a stock market index (or indices) without risking your capital.

Disadvantages – you will not get the full increase in a stock market index (or indices) and if markets fall you may only get a return or your original capital.  These investments do not benefit from the £85,000 of protection offered to structured deposits.

Tax Treatment – the gains will be taxed under the capital gains tax regime unless held in an ISA.

Structured investments with capital at risk (SCARPS) How and when capital can be lost is explained in detail and it is then possible to attempt to quantify the risk being taken and whether it is acceptable.

Advantages – structured products with capital at risk usually provide higher potential returns because you are taking a risk that you may not receive all of your capital back. 

Disadvantages – as structured investments with capital at risk are fixed term investments the maturity date might come at a time when markets are against you.

Tax Treatment – the gains will be taxed under the capital gains tax regime unless held in an ISA.

For further information see the links below

Investment Bonds

Investment bonds are technically life assurance bonds and that explains their unusual tax treatment.  They can be either issued by a UK company (onshore bond) or an overseas company (offshore bond).

Advantages (Onshore investment bonds)– are taxed internally and so any withdrawals are tax-free to nil and basic rate taxpayers.  Higher rate taxpayers have additional income tax to pay on surrender.  However, up to 5% of the original capital can be withdrawn annually, with the tax deferred until the entire bond is surrendered. 

Disadvantages (Onshore investment bonds) – making an investment in an onshore investment bond would generally be of no real benefit to anyone not fully using their annual capital gains tax exempt amount.   

Advantages (Offshore Investment bonds) are not taxed internally and therefore benefit from ‘gross roll-up’ of investment returns.  However, on surrender they are fully subject to income tax.  As with the onshore bond, up to 5% of the original capital can be withdrawn annually, with the tax deferred until the entire bond is surrendered.  Offshore investment bonds can be attractive to non tax payers.

Disadvantages (Offshore Investment bonds) – there is no real advantage for tax payers in investing in an offshore bond rather than an onshore one.

Tax Treatment – investment bonds are taxed under the income tax regime rather than the capital gains tax regime.  The bonds do not produce income (although you can take regular withdrawals of capital) and that makes them especially attractive for holding in trust for inheritance tax purposes.

For further information see the links below

Pensions

Pensions have always been tax-efficient but they have taken on a new lease of life in recent years and now provide much greater access for those with personal pension funds once they reach age 55 (rising to 57 in 2028). 

Advantages – ideal for long term investing in a tax-efficient way.  Personal pension funds can be left to others free of inheritance tax and allow for inter-generational planning.

Disadvantages – contributions are limited each year to 100% of your income or £40,000 (whichever is the lower) and funds cannot be touched before age 55 (rising to 57 in 2028). 

Tax Treatment – Pension contributions currently attract tax relief at your highest marginal tax rate and enable money to be withdrawn from a limited company without paying income tax or national insurance contributions.  At present the first 25% of your pension fund (within the lifetime allowance) can be withdrawn free of tax.  Withdrawals in excess of the first 25% suffer income tax.

For further information see the links below

Venture Capital Trust (VCT)

VCTs are a form of investment trust which invest in unlisted and AIM (Alternative Investment Market) listed companies.  They are public limited companies (PLC) which are owned by their shareholders. 

Advantages – you are able to invest in companies which would not generally be available to retail investors. 

Disadvantages – the risk of capital loss is high due to the small number of underlying investments in a typical VCT.  Few VCTs make capital gains and the benefit is really limited to the tax free dividends. VCTs  and are not suitable for the majority of investors.

Tax Treatment – you can obtain 30% tax relief on your investment into a new issue of a VCT.  Dividends are tax free as are capital gains.

Enterprise Investment Scheme (EIS)

These are similar to VCTs except that the risk of loss is even higher due to the even smaller number of individual investments involved.

Advantages – you are able to invest in companies which would not generally be available to retail investors. 

Disadvantages – the risk of capital loss is high due to the small number of underlying investments in a typical EIS.  Few EISs make capital gains and the benefit is really limited to the tax advantages.  EISs are not suitable for the majority of investors.

Tax Treatment – you can obtain 30% tax relief on your investment into a new issue of an EIS.  Dividends are tax free as are capital gains.  You can also roll-over capital gains from other investments until the EIS is sold.

For further information see the links below

Important