One of the key groups that risked paying a high price for the government’s requirement to target niche taxes is of course those people who pay capital gains tax. Capital gains tax is paid on investments in shares and other assets outside of the protective wrappers of pensions, ISAs and investment bonds.
Even though it is largely just a tax on success, some still fear it deeply and are willing to compromise their investment returns to avoid it. People can hold onto assets that they know are unsuitable for them to avoid crystalising the tax. Avoiding paying this tax can become a goal in itself rather than making the overall portfolio deliver on its promise.
Our view has always been and continues to be that this is a grave error. At 20% or 24% it makes little difference. The key decision for investors is to invest in the right things rather than try to arrange our financial affairs to avoid paying tax on our gains.
For evidence of this we can look at a simple illustration of a £500,000 investment in our 30% equity (ASPIM 3), 50% equity (ASPIM 5), 70% equity (ASPIM 7) and 90% equity (ASPIM 9) portfolios over the past ten years to compare the results. It tells us a clear story. The biggest drivers of results have been whether you picked a portfolio that performed well and the level of risk you were willing to take.
The details of how we have reached our illustration are contained below. However, in summary, an investment in the ASPIM 50% equity portfolio would have grown from £500,000 to £857,964 over ten years, paying 20% capital gains tax and making a reasonable number of portfolio changes each year. A 24% capital gains tax rate would have reduced this gain to £853,073. So extra tax of around £3891 is paid over ten years. However, the investment in the IA Mixed Investment 20-60% Share sector would have grown to £733,519 at the 20% tax rate or £731,633 at the higher tax rate. The additional return earned by investing in ASPIM Growth 5 here is £121,439 at the higher tax rate over ten years – a gain that dwarfs the difference attributable to tax. Getting the investments right then appears far more important than worrying about small tax differences.
Using a CGT allowance The CGT allowance is £3,000 a year and it is ‘use it or lose it’. This means that a portfolio that re-balances each year is likely to make use of this allowance to remove some tax liability each year. For a hypothetical £250,000 investment in our 50% equity portfolio the ability to make use of this allowance would have saved around £6,676 in our model at the 20% tax rate over the past decade, rising to £7,929 at the 24% tax rate. This saved tax would have been due had the portfolio not realised any of the gains until it was sold ten years later – as would have been the case were the assets all held in a single fund and only able to make use of one year’s allowance.
Our conclusion from the budget is clear. Reeves should focus on getting Britian’s long-term investment decisions right. As investors, we should also focus on making the best long-term investment decisions, rather than spending too much time worrying about the tax we pay if we do get it right.
A £100,000 investment over the past ten years would not have incurred a CGT gain above the allowance
A £250,000 portfolio would have incurred slightly more tax at the 24% rate over ten years but would have more than doubled in value
Past Performance is Not a Guide to Future Returns
Source: FactSet/ASPIM. Return of ASPIM Growth 3, ASPIM Growth 5, ASPIM Growth 7, ASPIM Growth 9 and IA Mixed Investment 20-60% Shares net of fees to 30/09/2024. Assuming for illustrative purposes only that 25% of the gain made each year was realised as a result of portfolio turnover.
Our Model
To reach the illustration above we have assumed that it was necessary to pay tax on 25% of the gain made each year because of the changes made on an ongoing basis to a portfolio to ensure it remains invested in what we believed were the best assets. We have not made any allowance for losses over this period which, if they could have been accurately calculated retrospectively, would have reduced the tax bill somewhat. We have assumed our investor in this illustration uses their £3,000 allowance to reduce their tax bill. The allowance was higher in the past but here we have assumed the lower rate. It is worth noting that an investor who had invested £100,000 in our 50% equity portfolio ten years ago would never have had an annual gain over £3,000 in any year in our model and would therefore not have paid any capital gains if they had their capital gains tax allowance available to them.