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Taming the bear

I certainly would not class myself as an investment specialist. I would, however, class myself as a concerned investor. Not an investor in a big way, I would add. No, an investor in a very ordinary and regular kind of way.

Like many investors these days, I would probably class myself as cautious – but not excessively so. Given the demands of developing Technical Connection and delivering services to our understandably demanding clients, I spend very little time monitoring and actively managing my investments.

Despite this lackadaisical approach to a very important subject, in these challenging investment times I have found myself reading more regularly beyond my usual tax/legal parameters in an attempt to find some justifiably optimistic commentaries or analyses for markets in the future. The more immediate that future is, the better.

In the course of that quest, I noted recently that a book published by ABN Amro and written by three finance professors at the London Business School – Elroy Dimson, Paul Marsh and Mike Staunton – finds that (among many other bearish conclusions) there is only a 50 per cent chance that the stockmarket will get back to its all-time high by 2018. That is 15 years.

It was the postscript to that comment that attracted my interest from the standpoint of what Technical Connection is about. Apparently, when reinvested dividends are included, the timescale shortens to 2010 – a significantly nearer date.

Now, a key discipline for all of us at Technical Connection is to read any and everything with a mind that asks: “So what?” So what does this mean for our clients and for the clients of our clients?

Note that I say clients, not customers, as I believe absolutely that the context of a long-term valued professional relationship (which is what I hope we have with our provider and adviser clients) means that the term client is much more appropriate than customer. The latter would imply that the connection is merely transactional. Or maybe it&#39s all just semantics.

Anyway, back to the point. And the point is the importance of reinvested income in overall returns. What does this mean to our clients and their clients? Given that any addition to the bottom line is to be valued, the value of having those reinvested dividends undepleted by tax can be exceptionally important in determining the final return for the client.

I have talked a bit in the recent past about the positive role that tax planning can play in improving investment returns, for example, through wrapper choice. Over the last couple of years, I have also noted the attractions of the capital gains tax regime (especially the combination of taper relief and the annual exemption) in maximising net returns from growth-oriented investments.

But, given this latest reminder on the importance of reinvested income, it is time for advisers to seriously consider the most appropriate tax wrapper for such income. It will not take a financial genius to appreciate that the lower the tax suffered on the reinvested dividends, the better will be the overall returns.

That is where advice comes in. I have said it before but it is worth repeating that, wherever there is choice, and the harder that choice is, then there is a need for and value attributed to advice.

Of course, an exempt approved pension arrangement and an Isa offer a very attractive home for reinvested dividends – and capital gains, for that matter. There is no tax payable and even (until April 2004, at least) a 10 per cent tax credit reclaim where the dividends are produced from equity investments held in an Isa.

The Isa also gives the investor access to investment funds incorporating growth and reinvested income tax-free.

The pension, of course, offers some tax-free cash and a taxable income. We all know the corollary to this is that the contribution into the pension will have attracted tax relief on the way in whereas the investment into the Isa will not. But I will resist the well-covered Isa versus pension comparison and conclude that, ignoring the point about tax relief on input, the Isa offers a very attractive home for reinvested income with no tax, tax credit reclaim (for the time being) and no personal tax on withdrawal.

This position is impossible to beat, especially when you add in capital gains tax freedom. But there is a limit – a maximum of £7,000 a year can be invested in an Isa. However, it is worth remembering that each of a couple can use this to invest a total of £14,000 a year. That is quite a bit for any ordinary couple to invest.

Moving away from Isas and pensions, we come to consider portfolio management services, collectives and insurance products, onshore and offshore. Perhaps the most fundamentally important point to keep in mind is that investment income (regardless of its nature) arising to collective or portfolio managers will be assessed on the investor, whether it is automatically reinvested or accumulated or paid out. This will not cause any further tax liability for basic-rate or non-taxpayers but will for higher-rate taxpayers.

This will not be so for investment income arising to life fund managers and this is something I will be looking at next week.


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