With summer now here, how many of you planned over the winter months to lose weight or work out, to ensure that you looked your best in the sun? Whether you managed it or not, all of you would have had clear expectations about what you wanted to achieve..........can you apply this theory to your investments or savings?
When it comes to your money, the one thing you do not want to do is to lose any of it.... but do you really understand what losing your money means? Let us look at the key areas for concern;
- We know that the price of your regular purchases generally increase over time and this is known as inflation. So the first figure we need to know, to ensure that you do not lose any money is inflation. This has averaged 0.60% per year over the last 10 years.
- The Revenue also charges you tax on the gains made on your savings and investments, so this can also have an impact on the value of your money. We now have our second figure, the rate of tax we will pay on our gains. This will vary depending on the investment type but will normally be 33% under CGT (Capital Gains Tax), 41% Investment Tax and 39% DIRT (Deposit Interest Retention Tax).
- If you decide to use a professional fund manager and advisor, then you will also need to pay their fee. This is normally expressed as a percentage of the amount you invest and is shown as an annual figure, although it is normally deducted daily. A charge of between 0.75% p.a. and 1.50% p.a. is to be expected. So we now have the third figure, the annual management charge.
Armed with these three figures, you can start to understand the factors that can affect your savings and investments. To do so we can create a scenario.
Let us assume you have a sum of €50,000.00, you have no immediate plans for the money, you are prepared to invest this over the next 5 years and would like a return on your money. On the latter point what return do you require? Or to keep the theme, what figure would you like?
With your new found knowledge, you have decided that you would like your money to grow by 2% a year, after allowing for inflation, tax and a management charge.
Understanding the Return.
If you do nothing or were to place your money in a safe deposit box for the next 5 years, it would no doubt be there when you open the box but would it still be worth the same?, the short answer is no.
Using the average inflation rate of 0.60% per annum, your money would have fallen by this amount in terms of buying power. It will still be €50,000.00 but to keep pace with inflation it should be €51,518.00. So by placing the money somewhere extremely safe but with no return, you have lost over €1,518.00.
So in our example you will need your investment to grow by 2.6% (the 2% return you require and allowing 0.60% for inflation.)
2. Fees & Charges.
In our example, we have assumed that all fees are included within the management charge levied each year and I have taken an average rate of 1.25% per annum. This will be added to the return needed above and the investment return figure you now need increases to 3.85% per annum (2% gain, 0.60% inflation, 1.25% charge)
The Revenue charge you on any gains made and this can seriously impact on the net return you receive. Depending on the investment type you will pay a minimum of 33% on any gains made. For this example, I will assume the highest rate applicable, currently 41%, which is levied on collective investments under which the mainstream investment houses would fall with their investment offerings.
To absorb the taxation, your required figure now jumps to 6.53% per annum. This gain taxed at 41%, gives you a net return of 3.85%, which meets the target we established earlier.
Here are the figures in a table format;
|Nominal Return||Real Return|
|Total Return||3.85%||Real Return||6.53%|
So having understood the figures that affect your savings and investments, you have been able to create the expected return you require to keep your money growing. What would appear a modest return of 2% above inflation requires a challenging investment target.
Like most individuals, you will normally be cautious with your money and you will generally select low-risk investment offers, without knowing the figures. Like most of us, the peace of mind that security brings is an emotional blanket, however you might not be aware of the effect this has on the return.
If we look at a low-risk, low volatile portfolio fund (which will include a mixture of assets) and take its performance over the last 4 years the annual return is 4.24%.
From this we should deduct tax at 41%, which reduces the net return to 2.50%. The next deduction is the annual management charge which at an assumed 1.25% reduces the return to 1.25% and finally inflation takes a further 0.60% off the figure, giving a net gain of 0.65%. This leaves little margin for growth on your money.
Engaging with a Financial Professional can help you navigate the investment markets and choose where best to place your money. Understanding the relationship between risk and return is important, especially when you have a clear picture of what you want to achieve........Just like the summer figure you dreamed of !!