In investment decisions, don't let the tax tail wag the financial dog!
A number of readers have written to ask what they should do with a lump sum of money they have received or may soon receive.
The first point is that, although tax may be an important aspect of the decision-making process, it is not the main consideration. As a tax consultant and not an investment adviser, when a client asks for investment advice, I tend to call in our specialist in that area, and simply advise on the tax implications of each option with a view to establishing which option will give the best overall return bearing in mind the client's needs and various other considerations.
The first rule you should follow if you are looking for somewhere to put your money is ask for advice from people who are qualified to give you the right answers.
The next rule to follow is to know what you want from the investment.
* Are you looking for an investment which will specifically result in tax saving? In this case you are probably trying to improve your cash flow. Are you looking for an investment that will provide you with a monthly flow of income? Or can your lump sum be somewhere where you can't touch it for a period of time?
* What would your financial situation be if you were to lose the lump sum? How much risk can you afford to take?
* What are your other financial circumstances? Do you, for example, have a mortgage bond as well as the lump sum which you now wish to invest?
These are only a few of the questions you need to ask, and the combined results of the answers will provide a profile which is unique to you. The type of investment that will be most appropriate for you will depend on how you answer the questions.
Looking at each of the questions:
* If you are looking for an investment that will improve your immediate cash flow, you are a provisional taxpayer, and are in a tax-paying position, then there are several opportunities available to you. For instance you might consider investing in a container. This would, generally, also give you some hedge against currency fluctuations.
* If you are looking for an investment that will provide you with a monthly flow of income, you will need to look at, for example, a bank deposit or unit trusts (the security you want for your investment might determine which to choose), or you could talk to your insurance adviser about what types of policies are available that will enable you to draw a monthly income.
Once you have established what is available to satisfy this monthly need, you need to look at the tax effectiveness of each option as the overall return on the investment will depend on the amount of tax you might have to pay on the income.
* If you don't need a monthly income, your options will expand and you will be able to look at investments which capitalise your income, with potentially greater returns. The insurance industry offers a number of options, as does the banking industry.
The possibility of investing in the share market or even property could be considered (again the amount of risk you are prepared to take might influence which option you choose, as well as the potential after tax returns).
* Your risk profile will have significant influence on your potential returns. The rule "higher risk-higher return" always exists. But you have to remember that you could also end up with nothing. This option offers the opportunity to invest in anything from the tote through the venture capital markets to a safe bank deposit. The choice will depend on your other needs.
* The rest of your financial life might determine the best investment you could make, for example, if you have a mortgage bond and are paying, say, 18 percent interest, it might be better to pay off some or all of the capital on that mortgage, since it would save the monthly interest you are currently paying, tax free. Your effective after-tax return would be a guaranteed 18 percent with no risk.
Clearly tax is an important factor but there are many others. Your situation is unique, so use the right adviser.