Contractors seeking low risk investments in times of market volatility, but who require a greater potential return than that offered by bank deposits, have a range of options, explains an expert independent financial adviser (IFA).
“Asset allocation is the guiding principle for contractors seeking investments which are low-risk and offer a greater return than cash on deposit,” he says. “Risk-averse contractors would be prudent to build a broad portfolio of equities, commercial property, bonds and gilts and make regular small contributions to reduce risk.”
Conversely, the expert says contractors open to risk might find times of market volatility a buying opportunity. “Buying during periods of market volatility will particularly appeal to contractors with a long term view to investing, such as those a long way from retirement or seeking to build a lump sum,” he adds.
Index linked gilts
However, risk-averse contractors should ideally avoid investing solely in equities, which are shares in companies, and should spread their portfolio, or allocate their assets, across lower risk investments such as gilts, which are government-backed securities.
“Index-linked gilts have offered particularly good performance during times of market turbulence,” continues the IFA expert. “These inflation-proofed government stocks represent a low-risk option as the UK is one of only two nations never to have defaulted on its debts.”
Whilst equity markets may lose considerable value when the markets are volatile, contractors who have diversified into government securities may have lost value in the equity element of their portfolio but gained value on the gilts they purchased.
Pension investment – relatively safe and tax efficient
“Pension investments are still one of the contractor’s best financial friends because of the tax relief available,” continues the IFA expert. “Even following the reforms and resulting caps on pension contributions introduced in recent Budgets, contractors can save up to 50% income tax on contributions to pension investments. For some higher earning contractors, the effective rate of tax relief is 60%.”
If a contractor’s pension fund is heavily invested into equities, any short-term loss of value will effectively just eat into the money that would have been given to the taxman if the cash had been left un-invested and taken as income.
“And due to the long-term nature of pension investments,” explains the IFA expert, “short-term losses incurred when equity markets fall in value are likely to be regained, and exceeded, over the life of the investment.”
Manage risk by drip feeding investments
According to the IFA expert, the risk-averse contractor seeking a relatively safe haven should manage their risk by ‘drip-feeding’ their investment: “Drip-feeding contributions to investments is the key to minimising the effects of any shorter-term market turbulence.
“This is because a contractor is only ever investing a small amount of cash at any one time,” he continues. “This helps to spread the risks involved in ‘timing the market’. Rather than betting everything on a single transaction, which may miss the crucial point when the market is at its optimal level and could result in heavy losses, contractors can instead potentially benefit from making a larger number of smaller investments.”
Drip-feeding contributions to investments is the key to minimising the effects of any shorter-term market turbulence
IFA expert
Regular, small investments effectively make a virtue of market fluctuations. Contractors buy when prices are lower to compensate for those months that prices are high. Over time this effect can have a substantial smoothing effect on returns.
Seek professional advice
The expert urges risk-averse contractors to seek professional advice from an independent financial adviser before making investment decisions. “There are a huge number of financial investment products on offer but each needs to be tailored to your specific attitude to risk and not all of them will be appropriate for contractors seeking a modest but relatively secure return on their investments.”
This is particularly true for contractors who are completely exposed to the roller coaster ride that the equity markets represent and who are persuaded to opt for unsuitable financial products.
“An often repeated mantra within contractor circles is that Self Invested Personal Pensions (SIPPs) are the way to go but hidden charges can make this particular route far more costly than it appears,” the IFA expert warns.
“Coupled with unnecessary cost, is the danger that busy contractors almost inevitably don’t have the time or inclination to carry out the reviews, rebalancing and regular trades to properly manage their own share portfolios and almost never pay heed to the asset allocation that is the proven key to long term performance.”