Knowledge Base. Terms, Definitions and Explanations
Our Learning Hub is a simple idea to help and aid your investment research. We thought it would be useful to explain and highlight some of the main terms you may come across when looking to invest. This keeps things simple and gives you a better understanding of the world of investment.
Bonds are loans made to large organisations and are a type of fixed-income investment. Governments and companies commonly use bonds to borrow money, as governments may need funds for things such as schools or roads. Companies often need to borrow money to grow their business, to buy equipment or property, for research and development or to hire employees.
A corporate bond is a type of debt security that is issued by a firm and sold to investors. The company gets the capital it requires and in return the investor is paid several interest payments that are pre-established at either a fixed or variable interest rate.
High-quality corporate bonds are considered a relatively safe and conservative investment, these are known as investment grade corporate bonds. Investors building balanced portfolios often add bonds to offset riskier investments.
A government bond is a type of debt-based investment, in the UK these are known as gilts. When you buy a government bond, you lend the government an agreed amount of money for an agreed period of time.
In return, the government will pay you back a set level of interest at regular periods, known as the coupon.
This makes gilts (bonds) a fixed-income asset.
Investment bonds are a lump sum investment and can provide easy access to their money by taking it out or paying money in whenever you can, and they provide an investor with the potential for medium to long-term growth on their money.
Investors need to be careful with investment bonds because many of them have exit penalties if you withdraw more than 5% of your original investment in any one year within the first 6 years of investing.
They also are treated very differently for tax purposes and can be subject to a chargeable gains calculation which could result in a substantial tax bill.
ISA. Individual Savings Account
These are offered by building societies, banks, asset managers, insurers and National Savings & Investments (NS&I). There are many different types of ISA to suit a variety of individuals including under 18s, and they each have a different purpose. You can only contribute to one ISA in each tax year but you can transfer previous years ISA contributions to a new provider without affecting your current tax year ISA allowance.
What is it?
|Cash ISA (basic)
|Stocks + Shares ISA (investment)
|£20,000 allowance, tax-free gains, no further tax on dividends, tax-free interest.
|Help to Buy ISA (H2B ISA)
|Savings account for first-time buyers
|£3,400 allowance in the first year; £2,400 thereafter, 25% top up, tax-free interest, closed to new savers on 30th November 2019
|Lifetime cash ISA (LISA)
|House deposit and/or retirement savings account
|£4,000 allowance, 25% top up, tax-free interest, only individuals aged 18-39 years old can open this account
|Lifetime Stocks + Shares ISA (LISA)
|House deposit and/or retirement savings account
|£4,000 allowance, 25% top up, tax-free interest, only individuals aged 18-39 years old can open this account, no further tax on dividends
|Junior cash ISA (JISA)
|Savings account for under 18s
|£9,000 allowance, tax-free interest
|Junior Stocks + Shares ISA (JISA)
|Investment accounts for under 18s
|£9,000 allowance, tax-free gains, no further tax on dividends, tax-free interest
Limited amount of cash you can deposit each tax year. Three types of cash ISA – Instant cash ISA (pay in and withdraw money at any time, variable rates of interest), Regular savings cash ISA (pay fixed rate of interest over a certain amount of time providing you deposit a certain amount of money each month), Fixed rate cash ISA (commit to locking away your money for a fixed amount of time to have a fixed interest rate – the longer the better).
Stocks + Shares ISA
Either opt for a managed account and pay fees for your investments to be managed for you or choose where to invest your money but you will still pay a provider a fee. Factor in risk before choosing the right investments for you.
Help to Buy ISA
The government pays a 25% bonus on what you save, the maximum being £3,000. The bonus is paid to the solicitor/conveyancer after you have completed your property purchase.
The government pays a 25% bonus on what you save, the maximum being £1,000 each year. This bonus is paid into your Lifetime ISA each month. If you are using your ISA for retirement, you can only pay into your account until you are 50 years old and wait until you are 60 years old to withdraw it.
You can pay into this each year until the child turns 18, which then converts to an adult ISA and they gain control of the money that is saved.
Unit trusts are an open-ended pooled investment product, meaning there is no limit as to how many people can invest in it and how much money can be invested. It is an unincorporated mutual fund made up of pooled money from investors who usually hold bonds and equities etc.
Unit trusts are themed and focus on specific areas of the world as well as different types of shares or bonds, for example you can invest in a UK All Companies fund, a North American or a Japan fund. Investing in a North American fund would mean the unit trust buys and sells shares listed on some or all of American stock exchanges.
You can choose a unit trust that is focused on generating growth and your money will likely be invested in shares that produce little or no dividends but have strong prospects for growth over the coming years.
Alternatively, you can choose to invest in an income-based fund where your money will be used to buy shares, government bonds or corporate bonds all of which produce a fixed or variable dividend or annual rate of interest. You can normally choose to have this income paid out to you on a regular basis or have it reinvested in a fund.
An investment trust is a close-ended fund that is set up by a company. This means that a fixed number of shares in the company are sold to investors. The capital raised from this is used to buy and sell shares on the stock market and therefore can make money for shareholders. This is done by investing in things such as property, or other assets that are chosen and managed by the investment manager as they create a portfolio of shares that are suitable for the type of investor and their needs.
Mutual Funds are American investment products. In the UK they are known as Unit Trusts. These provide one fund in which an unlimited number of people can invest, the idea being you can diversify or spread your investments across a much wider range of assets being part of a big fund than you would be able to do on your own.
ETFs. Exchange Traded Funds
An Exchange Traded Fund is a group of different securities that are pooled together into one fund. They are open-ended funds. ETFs are traded on an exchange just like shares. The price of an ETFs shares will fluctuate throughout the trading day as the shares are bought and sold on the market.
There are many different types of ETF available to investors, for example:
1. Bond ETFs – may include government bonds, state and local bonds and corporate bonds.
2. Industry ETFs – track particular industries such as technology, oil and gas sector, or banking.
3. Currency ETFs – invest in foreign currencies, for example Canadian Dollar or Euro.
4. Inverse ETFs – attempting to earn gains from stock declines by selling a stock, expecting the value to decrease, and then repurchasing the stock at a lower price.
5. Commodity ETFs – invest in commodities like gold and crude oil.
- Access to many stocks across various industries.
- Risk management through diversification.
- ETFs focus on targeted industries.
- Single industry focus ETFs limit diversification.
- Lack of liquidity hinders transactions.
- Actively managed ETFs have higher fees.
SIPP. Self Invested Personal Pension
A flexible, tax-efficient retirement saving account that helps you to save for your long-term future. You can pay money in the plan in lump sums or a monthly amount – usually subject to a minimum up until the age of 75 and can start withdrawing money from the age of 55. A SIPP gives individuals the freedom to allocate their assets in a wide range of investments that are approved by HMRC. It is a defined retirement contribution plan that is offered to tax-payers in the UK. Individuals can take up to 25% of their funds tax-free.
SASS. Small Self-Administered Scheme
This is a type of occupational pension that is managed independently by directors of a company. It provides retirement benefits to both directors and any other senior staff (which can sometimes include family members, regardless of whether they work for the company or not) as each member becomes a trustee. The number of members is limited to 11 with a SASS, therefore these are most common in family run businesses. Each trustee will have some say as to where the money is invested and what goes on with plan. You can start withdrawing benefits from this plan from the age of 55 in the standard way and has the same option as the SIPP of taking 25% as a tax-free lump sum.
Tax and your investments
When you invest in shares through an investment portfolio, you may pay several different types of tax, such as Stamp Duty, Dividend Tax and Capital Gains Tax.
Although the corporate bonds are the simplest form of a bond and the most readily available, they are the least advantageous from a tax point of view, as nearly everything about a corporate bond is taxable. However, corporate bonds pay the highest yields as they pose the highest default risk. Corporate bonds can be taxed in three ways, firstly through the interest that is earned on the bond, secondly through the capital gains or losses that are earned in the early sale of the bond, then finally through the original issue discount.
Investment bonds are not ‘qualifying’ policies for UK tax purposes and therefore ‘chargeable event gains’ can arise at any time. Any withdrawal from your investment bond may create what is called a ‘chargeable event’. When a chargeable event happens, this may create what is called a chargeable event gain, which you may have to pay income tax on. This may also affect your entitlement to personal allowance.
ISAs are tax-free. Each tax year, you get an allowance which sets the maximum you can save in your ISA – or across several ISAs if you choose to have a mix of accounts for different reasons. The maximum you can save is currently £20,000 for 2023/24 between April 6th one year and April 5th the following year.
In the UK any income distributions or capital growth from unit trust investments could be subject to either income and/or capital gains tax. The amount of tax you may potentially be liable for depends upon the type of share class you have chosen and the level of income or capital growth you have received. If you receive dividend distributions, you are given a £2,000 dividend allowance, therefore, all income paid below this amount will be taxed at 0%.
Any dividend income paid above this amount will be taxed as follows:
- 7.5% (for basic-rate taxpayers).
- 32.5% (for higher-rate taxpayers).
- 38.1% (for additional-rate taxpayers).
If you receive income distributions as interest this will be paid to you gross and will be taxed as savings income, which means the first £5,000 could be taxed at 0%.
This rate allowance reduces by £1 for every £1 you earn as non-savings income over your personal allowance (currently £12,570) therefore, it does not apply to anyone earning over £17,500. However, basic-rate taxpayers can use their tax-free personal savings allowance of £1,000. This reduces to £500 for higher-rate taxpayers and £0 for additional-rate taxpayers.
Any income distributions paid above these amounts will be taxed as follows:
- 20% (basic-rate taxpayers).
- 40% (for higher-rate taxpayers).
- 45% (for additional-rate taxpayers).
Capital gains tax is paid by both UK and Non UK residents, and may be due when you transfer, gift, sell or exchange (either all or some of) an asset. You pay capital gains tax on assets such as investment trusts, funds, ETFs, land, shares, investment properties, second properties, art and any other possessions that are worth at least £6,000. You do not pay capital gains tax on assets like pension investments, ISA investments, your family home (this is correct for most cases however some exceptions such as if your property is on land bigger than 1 acre or if you rent part of your property), UK government bonds, venture capital trusts, possessions that depreciate.
Every tax year, you have a personal capital gains tax allowance. This tax year, the amount is £6,000 for individuals or up to £3,000 for trusts. You can work out how much you will pay in capital gains tax by calculating your total gains in a tax year, taking away your annual capital gains tax allowance from your gains, and finally work out how much tax to pay. Depending on your taxable income in that year, capital gains tax is normally charged at 10% or 20%. Your gain is added on to all your other taxable income in that tax year in order to calculate the rate of tax. The gains for residential property are taxed at 18% and 28%, depending on other taxable income. For trusts, capital gains tax is charged at 20% or 28% depending on the asset.
For an investor, an investment trust is taxed the same way that a unit trust is taxed.
There are two main tax benefits to opening a SIPP. The first is that your investments will grow free from capital gains tax and income iax. The second benefit is you receive government tax relief when you are paying into a SIPP.
Amount you pay (80%)
Government adds (20%)
Total invested in your SIPP
Higher rate tax payers can claim back up to a further
Effective cost for higher rate tax payers as little as
* maximum contribution for non-earners
Any contributions members make to an SSAS pension are eligible for tax relief. Basic rate taxpayers get a 25% tax top up, therefore if you want £100 to go into your pension you pay £75 and HMRC adds £25.
If you pay a higher rate of tax, you will be able to reclaim additional tax relief through your tax return. Contributions paid into the scheme by the employer also qualify for tax relief which can help reduce its total tax liability.
Active vs Passive Investment Managers
Generally, active managers devote most of their time to portfolio construction. In contrast, passive strategy managers devote less time to this activity.
Active portfolio strategy uses available information and forecasting techniques to achieve a better performance than a portfolio that is created, diversified and generally left to its own devices – in other words, a passive portfolio that will do what the market does.
A passive portfolio strategy involves minimal input and relies on diversification of investments to match the performance of some market index.
This is an investment strategy that suggests buying shares that appear to be under-priced using an analysis of the company fundamentals (financial accounts). Famous value investors include Warren Buffett, George Soros and Ben Graham.
This is a strategy focussed on building capital by investing in the shares of companies that show signs of achieving above average growth even if the share price seems expensive. Examples would be companies like Amazon, Facebook and Apple.
Help and Advice
If you have a question or would like further information on ant of the areas listed in our Learning Hub, please contact us. We’re on hand to help and give you impartial and clear explanations.