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Case Study: The dangers of DIY investing

Matthew Stephens Prudential 2012

The problem: The increased clarity of charging brought about by the RDR has caused many clients to review their relationship with their financial adviser. Some clients have expressed a belief that taking a do-it-yourself approach would be cheaper as they do not need to add an extra layer of cost to the transaction. What are the pitfalls of the do-it-yourself approach?

The solution: Almost a third, 31 per cent, of DIY investors are not aware that the way they buy financial products, either direct from a provider or from a platform or fund supermarket, can impact the cost of their investment.

Recent research from Prudential suggests that many DIY investors, those who self-select the majority of their investments, are failing to consider important taxes and charges when making investment decisions.

Almost half, 44 per cent, admit they do not know which wrapper product would be most appropriate for their circumstances, a further 37 per cent are not sure how to avoid tax traps, and a fifth, 19 per cent, are not confident they will keep under their annual capital gains tax threshold.

When questioned about DIY investments that fail to perform as expected, more than a fifth, 21 per cent, cite their lack of clarity around product or fund charges as the main reason for the underperformance.

Using the CGT threshold correctly helps investors maximise returns in a tax-efficient way. However, despite most DIY investors, 81 per cent, saying they understand CGT, only 28 per cent know the allowance is £10,600 for 2012/13, with 13 per cent overestimating it.

Our research shows wealthy DIY investors, those with over £250,000 invested, are more likely to know the CGT limit but 56 per cent of them still do not know the exact figure. This shows they are unlikely to be maximising the tax-efficiency of their returns.

Furthermore, just 7 per cent of DIY investors claim to use their capital gains tax allowance each year, rising to 15 per cent for high net worth investors.

Investing in a tax-efficient way is not something that happens automatically. Investors can save substantial amounts by maximising exemptions and limits, using Isas and the CGT annual exemption, for example, as well as other tax-efficient investment vehicles. But this can be complicated and will usually be more successfully achieved with advice from a professional financial adviser.

Investing without advice from an expert may be cheaper initially. However, without a clear understanding of all the relevant considerations, it could be very costly in the long-run.

Many DIY investors say they are confident about making financial decisions on their own, but our research highlights a worrying lack of understanding.

It is vital to understand clearly the costs/charges, risks and tax implications applying to an investment before making a commitment.

Matthew Stephens is a tax expert at Prudential


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