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Investment portfolios | The Principles of Success

By Mark Quinn - Topics: investment diversification, Investment objectives, Investment portfolios, Investment Risk, Investments, investments in Portugal, Portugal
This article is published on: 18th May 2022

18.05.22

The world of investments can be intimidating, even for the most seasoned investor. Here, we will put aside the jargon and push past the hype of ‘the next big thing’, and instead focus on the key principles that every investor should know when building a portfolio of investments; irrespective of how engaged or involved you wish to be.

Ideally, you should look at your assets as a whole – your pensions, property, savings and investments, rather than at each area or structure in isolation. This way you can apply the principles to your wealth as a whole and be in the best position to potentially meet your financial objectives.

Asset allocation is key to investment success
Asset allocation is the percentage of each type of asset class making up your overall investment portfolio. In turn, asset classes are groupings of similar types of investments such as cash, equities, commodities, fixed income, or real estate.

The key principle behind asset allocation is to include asset classes that behave differently from each other in different market conditions to reduce risk and generate potential returns. For example, if equities are falling in value, certain fixed income assets may be rising.

The goal here is not solely to maximise returns but to blend your holdings to meet your goals, whilst taking the least amount of investment risk. The right allocation for you will depend on several factors such as your willingness and ability to accept losses, your investment time frame, and your future needs for capital – unfortunately, there is no one size fits all.

Many studies have shown that asset allocation is the most important driver of portfolio returns, so getting this first step right is critical.

Diversification to reduce risk
Once you have decided on the right asset allocation for you, you must then pick the individual types of holdings or investments within each asset class. Each asset class is broken down into subclasses, for example, fixed income includes holdings such as fixed deposits, gilts and government or corporate bonds.

It is not enough to simply own each type of asset class; you must also diversify within each asset subclass. For example, taking corporate bonds which is a type of fixed income asset class, you can hold them in many different types of companies, industries, currencies, countries, or long or short term.

Rebalancing
As assets perform differently over time, the initial percentage asset allocation will deviate over time. A typical example is the huge increase in the US stock market over the last couple of years which, whilst good for investors’ returns, will have increased the level of share exposure. This increase in the value of equity holdings because of the sustained rise will lead to increased risk across the portfolio as a whole.

This can be solved by regular rebalancing to ‘reset’ the portfolio to your original asset allocation. This involves selling holdings that are overweight and buying ones that are undervalued.

Rebalancing also provides the ideal opportunity to revisit your financial goals and risk tolerance, and to tweak your asset allocation accordingly.

investment portfolio

Long term perspective and discipline
As humans, our emotions can lead to poor decision making when it comes to investing. Decisions that seem logical in daily life can result in poor investment returns, with many retail investors selling through fear at the very point they should be buying at lower prices, and conversely, buying at much higher prices during a gold rush.

It is vital for most investors to keep a disciplined approach as it is easy to get caught up in the daily noise of the markets.

Minimise costs and maximise tax efficiency
Einstein described compounding as the 8th wonder of the world and the effect of compounding applies to fees. A charge that might seem small at the beginning can turn into a significant cost over time and research has shown that lower-cost funds tend to outperform in the longer term.

As a simple example, assume a €100 investment and no growth. After 10 years, an annual charge of 2% will result in €82, a 0.2% charge would result in €98.

Focus on minimising fund, structure and adviser fees. In the world of investing, more expensive does not necessarily mean better.

Tax is an often-overlooked cost, which if minimised can lead to the same positive compounding effects over time. This is done by ensuring that your investment portfolio is structured correctly for your resident status, and it might be different planning for normal residents, Non-Habitual Residents, or depending on if your move to Europe is for the rest of your life or if you intend to return to your home country in the future.

Withdrawal strategies
If you are taking income from your investments, you should consider the way in which you do this and the order. Not only will this affect the type of investments you hold within your portfolio, but it could also affect how you hold your portfolio and provide tax planning opportunities or pitfalls.

Focus on total return
With interest rates at historically low levels, it is difficult to rely solely on income returns in this investment environment. The total return is a truer picture of performance and takes into account the capital appreciation as well as the income received.

Be boring!
To quote Warrant Buffet, one of the world’s most successful investors: “Lethargy, bordering on sloth should remain the cornerstone of an investment style”.

Do not try to chase returns or the trends in investments – stick to tried and tested assets. At Spectrum, we only use investments that have worked over the long term, are easy to understand, daily tradable and transparent.

5 reasons cash might not be king

By Mark Quinn - Topics: investment diversification, Investment Risk, Investments, investments in Portugal, Portugal
This article is published on: 16th May 2022

16.05.22

In the words of Warren Buffett, “The one thing I will tell you is the worst investment you can have is cash”.

If one of the world’s most successful investors believes this, let’s look at some of the reasons why holding large amounts of cash is bad for long-term financial planning.

Inflation
We all need access to cash for daily spending and emergencies, so it is important that you hold enough cash on deposit for if the boiler breaks! But holding large amounts of cash over long periods is damaging when the interest rates are well below the rate of inflation.

To illustrate this in real terms, if your annual spending was £10,000 in 2011, you would need £12,968 in 2021 to make the same purchases as inflation averaged 2.6% p.a. However, during that same period, the average savings account interest rate was 1.6% p.a. so the same £10,000 in a bank account would only have grown to £ 10,160.

Low-interest rates

Interest rates offered by banks to customers rarely beat inflation, so using this as a long-term savings strategy is not ideal.

According to the most recent data available provided by the Bank of England and Portugal, the average UK deposit interest rate offered in December 2021 was 0.3% and the average rate in Portugal was 0.06% as at December 2020.

With inflation currently sitting at 5.4% and 3.3% for the UK and Portugal respectively, we can see that inflation will rapidly erode the value of your savings.

Taxation
One of the commonly overlooked factors when making any investment is the tax consequence. In the UK there are great tax-free savings vehicles such as ISAs, but here in Portugal, the choice is much more limited but that does not mean that tax-efficient savings are not available.

For those with NHR, there is not so much of a concern as foreign earned interest is tax-free. However, for normal residents, all interest paid is taxable at 28%. Please note, interest from bank accounts held in blacklisted jurisdictions such as Guernsey, Jersey and the Isle of Man is always taxable at 35%.

5 reasons cash might not be king

Investments usually outperform cash in the long-term
Most people feel more comfortable holding cash, maybe because they do not understand the stock market or they are reluctant to seek financial advice.

It is true, investing in the stock market does carry some risk and you will experience volatility which can be unnerving, but over the long-term markets have outperformed cash.

The Barclays Equity Gilt Study 2019 analysed cash, equity and gilt performance from 1899 to 2019 and it found that £100 invested in cash in 1899 would be worth £20,000 in 2019; a stark contrast to the £2.7m it would worth if invested in equities over the same period.

We might not all live to see returns over 120 years, but even with the global health and economic crisis today, many global stock markets finished the year higher than they started. For example, Morningstar’s Global Markets index was up nearly 15% by mid-Dec 2021, whilst banks were offering returns below 1%.

Dividends
Stocks and shares pay dividends in addition to the expectation that their price will increase. Cash only pays interest, and with inflation, there is a near-certain expectation our cash value will erode in real terms over time.

Lastly, what are the alternatives? Simply put, investing. What you should be investing in and where will be dependent on several factors such as your goals and the risk you can, and are prepared to, take. If you would like to discuss your options, please get in touch.

Measuring investment performance

By Mark Quinn - Topics: investment diversification, Investment objectives, Investment Risk, investments in Portugal, Portugal
This article is published on: 11th April 2022

11.04.22

There are several different ways of measuring your investment performance, and I will run through some simple tips to allow you to dig deeper into your portfolio.

Firstly, do not forget to factor in fees such as adviser and management fees and structure costs when looking at returns. I have seen the cost of some investments run as high as 4% p.a. through hidden commissions and explicit charges. These have been disguised by strong market performance over recent years, but are likely to be exposed if we experience leaner years in markets in the future.

Simple benchmarking
A simple and quick method of comparison is looking at interest rates on cash accounts. If your investment returns are generating the same returns as cash on deposit, why are you taking the market risk?

Similarly, take into account inflation. If you generate a 3% return and inflation is 2%, your net return is just 1%; is this what you thought you were achieving?

Lastly, look at what similar passive investments have done. These types of funds simply track a stock market index and are inexpensive. If you are paying a fund manager to outperform and add value by trying to achieve higher returns, have they done this?

measuring investment performance

More in-depth methods

Market indices
A market index tracks the performance of a group of shares or other investments e.g. the S&P 500 index which tracks the performance of the largest 500 shares in America. They can be a useful barometer for the ‘health’ of an investment market as a whole but it is important to use them appropriately.

For example, you cannot meaningfully compare the performance of the S&P 500 index (100% shares) with a portfolio that consists only 40% of shares. Similarly if you are comparing a euro denominated portfolio with the US market which is denominated in dollars, then again this is not necessarily an appropriate comparison.

The downsides of using indices as a comparison are therefore addressed by the use of:

Peer group
A peer group allows you to compare investments that are similar in nature e.g. a specific class of investments or geographical region, and because you are comparing “like for like” it can be a more meaningful comparison tool.

Morningstar.com is a particularly useful tool in this respect and can guide investors with regard to an appropriate benchmark and peer group.

Quartile rankings
These are used to compare returns of investments in the same category over a period of time. Investments in the top 25% are assigned quartile rank 1, the next 25% quartile 2 etc.

They can be useful in tracking consistency – what is important is not the quartile ranking in any one period, but they allow you to track trends over multiple periods and time frames.

There is no one way, or right way, to compare performance and you will likely need to combine several measures to get a more accurate reflection of performance. Even more importantly, this should be done regularly to ensure you are doing all you can to achieve your financial goals. Finally, you should take into account the risk you are taking to achieve a set level of return, and this will be the focus of a future article.

If you would like to discuss your performance or how best to build your own portfolio of investments, please get in touch.

Investing as a resident of Portugal

By Mark Quinn - Topics: Investment Bonds, Investment objectives, Investment Risk, investments in Portugal, Portugal
This article is published on: 23rd February 2022

23.02.22

If you are relocating to Portugal (or if you are already resident here) it is important to carry out a review of your investments to make sure they will be tax-efficient in your new county of residence.

Just because your investments are tax-efficient in one country does not mean that the tax advantages will transfer to another county. There are various ways of investing as a Portuguese tax resident, including directly held stocks and shares, collective investments, trust and pension structures. One structure that is beneficial to use in Portugal, and which is used widely across Europe as a whole, is the investment bond.

The benefits of investment bonds

There are several benefits to using investment bonds:

  1. Tax deferral during accumulation phase – gains within an investment bond grow free of tax, known as ‘gross roll up’. This means you can benefit from compounding and tax is only payable when withdrawals are made i.e. the gains are realised
  2. Low effective tax rates when withdrawing funds from the policy – Only the growth element of any withdrawal is taxable, and further tax savings are available after 5 and 8 years. It is important to note that this preferential tax treatment is enjoyed if you are a Non-Habitual Resident or a standard Portuguese taxpayer
  3. Control of the timing of tax events – the bondholder can control the timing of any withdrawal which creates the taxable event. This can be done to coincide with low-income periods, for example
  4. Investment flexibility and diversification – as income and gains roll up free of tax within the structure, you are free to pursue any investment strategy without being constrained by the potential tax consequences of re-balancing or switching between strategies. Additionally, these structures can accommodate a wide range of currencies, asset classes and fund management styles, such as discretionary fund management, index trackers and self-management
  5. Simplification of tax reporting – You are only required to report and declare any income and gains when withdrawals are made. This makes local tax reporting very simple
  6. Portability – the investment bond structure is widely recognised in other jurisdictions so you do not necessarily have to surrender your investment if you relocate from Portugal
  7. Succession planning – investment bonds allow flexible and certain transfer of wealth to beneficiaries. This may not be possible with other investment types and the default “forced heirship” provisions under Portuguese law
  8. Inheritance tax savings – with the correct planning, holding wealth in an insurance bond could mitigate or even completely avoid UK inheritance for British domiciles
  9. Estate administration – in the event of death, the proceeds of the structure can be distributed seamlessly to your beneficiaries without the need for any formal probate process
Investing as a resident of Portugal

At Spectrum, we can help analyse your options and if appropriate for you, advise on how to set up the optimum bond structure for you and your family, including:

  • How to set up the structure for maximum control and flexibility
  • Selection of a suitable provider and jurisdiction to hold your investment in, being cognizant of the relevant double tax treaty with Portugal
  • Which currency to hold the investment in and advise on the underlying fund choice
  • Consideration of trust options
  • Regular reviews of the structure and investment strategy on an ongoing basis in light of ongoing changes in taxation and investment markets

You can contact me using the form below to find out more on the services we offer and to arrange a free financial consultation.

*Mark Quinn is a Chartered Financial Planner with the Chartered Insurance Institute and Tax Adviser qualifying with the Association of Tax Technicians.

What is a good investment return?

By Mark Quinn - Topics: investment diversification, Investment objectives, Investments, investments in Portugal, Portugal
This article is published on: 11th February 2022

11.02.22

This was a question posed to me by a client recently. I was taken aback by the question as most clients (rightly or wrongly) tend to have fixed expectations about what a ‘good’ and ‘bad’ return is. It was an excellent question and I answered by saying that ‘good’ isn’t absolute; it is relative to the economic and financial environment in which we live.

For example, I remember walking into Cheltenham & Gloucester, Manchester in 1997 and opening a savings account and earning 7.5% per annum! Back then, the Bank of England base rate was 7.25%. If at the same time you were achieving a 7.5% pa return by investing in say, shares or gold, this would not be a ‘good’ rate of return because you would be taking much more risk to achieve the same return as that offered by the bank and only a few basis points above the base rate.

So, with the Bank of England interest rate currently sitting at 0.50% and the ECB base rate at a negative figure of -0.50%, a 4% or 5% pa return looks very attractive today, even though it would not have done in 1997.

Another factor we need to consider when assessing what a ‘good’ return means is the level of risk we take to achieve the return.

In constructing our portfolios at Spectrum, we always consider performance in the context of risk taken to achieve that return. For example, two funds can both achieve a 5% pa return but one fund may have fallen in value by 20% whereas another fund may be down just 5%. Clearly, the latter is a better fund.

We can analyse this in more detail by considering “scatter diagrams” which is an interesting way of looking beyond headline performance figures.

investment return

CLICK ON THE IMAGE ABOVE FOR A LARGER VIEW

This type of chart shows performance on the vertical axis and compares this with volatility on the horizontal axis, which is a measure of risk.

Ideally, we want a fund that is in the top left of the chart i.e. it has very low risk and a very high return. Unfortunately, we know that we cannot have our cake and eat it and in the real world we have to take risk to achieve return, but the important thing that these types of charts highlight is if you are taking risk and not being rewarded for it.

For example in the above chart, fund B (purple square on the far right) is taking a high level of risk relative to the other funds as it is the furthest right on the horizontal axis and it is achieving a high level of performance as it sits high up on the vertical axis. Now, looking at fund A (aqua square second from the right), it has achieved a higher level of performance than fund B but has experienced much less volatility. It is clearly a superior fund, achieving higher performance with less risk.

The other factors we must also take into account when considering what a ‘good’ return means are the cost of running the investment and the impact of taxation.

Ensure you consider all costs when assessing whether you are getting a good return or not. Each fund manager will charge a percentage ongoing fee, but do not forget to factor in transaction costs on buying and selling investments.

Often more damaging is the taxation. Are you paying capital gains tax on each transaction as it occurs? Could you roll this up instead and benefit from compounding? Or are the tax implications impacting the decisions you make as an investor?

For example, a buy-to-let property that offers an attractive gross yield of 6% per annum looks like a good return on the surface, but once ongoing costs and tax are factored in, your net yield could be much lower, at around 2-3%.

Lastly, when comparing investments, you must always do a like-for-like comparison. So when you are benchmarking your investment ensure it is against its peers, for example, there is no point in comparing the gross return of your buy-to-let property against a BP stock you hold.

How are my savings and investments taxed as a Portuguese resident?

By Mark Quinn - Topics: investments in Portugal, Portugal, Saving, Tax in Portugal
This article is published on: 9th February 2022

09.02.22

You are probably quite au fait with your home country’s investment structures, options, and practices, but what happens when you move abroad?

The first step in ensuring you are doing the right thing is getting a good understanding of the basic principles in your new country. Here I briefly run through the tax treatment of the most common income sources, and this should help you make a decision as to whether you should look more seriously at restructuring your wealth.

Bank accounts
Any interest must be declared in Portugal, irrespective of where the account is located or if you use it or not.

If you have Non Habitual Residence (NHR) status, interest earned on foreign accounts is generally tax-exempt in Portugal, unless the account is held in a blacklisted jurisdiction such as Guernsey, Jersey, or the Isle of Man, in which case it is taxed at 35%. So, if you are still holding large sums in these ‘tax-havens’ you should certainly be looking to restructure this.

If you are a non-NHR, all bank interest earned on foreign accounts is taxed at 28% or 35% for blacklisted jurisdictions. It is possible to opt for this to be taxed at scale rates instead, but this will have an impact on the taxation of other assets, so it is best to discuss this with your accountant when making your annual return.

Interest from Portuguese bank accounts is always taxed at 28%%, irrespective of your NHR status.

Dividends
We usually see individuals with dividends paid from their own companies, directly held shares, or investment portfolios. This is a great source of income if you are a NHR as these are generally tax-free in Portugal during the 10-year period.

It is worth thinking about what you are doing with the income once received. If you are not spending it all and it is accumulating in a bank account earning little or no interest, you should consider investing this in a tax-efficient manner to get your money working for you.

For normal residents, dividends are taxed at 28% (or 35% if from a blacklisted jurisdiction) but there is potential for tax savings if you can restructure.

Rental income
For NHRs, rental income from non-Portuguese property is possibly exempt with progression. This means that although it is not taxed, the income is added to your other income sources for the year and counted when running through the tax bands.

It is also likely that this type of income will be taxable in the country that the property is located and in Portugal. Taking UK property as an example, you will declare and pay the relevant tax in the UK and also declare this income in Portugal. Whilst with NHR, there is no further tax to pay in Portugal, you could be paying tax in the UK if the income exceeds your annual allowance.

For those with large property portfolios, it might be worth restructuring during the NHR period to take advantage of the capital gains tax break and reinvest the proceeds in a more tax-efficient way, because post NHR this income is taxable at scale rates in Portugal.

Rent from Portuguese property is fully taxable at scale rates, so is not a very tax-efficient source of income and you could generate a more tax-efficient income from other sources.

Pension income
Those with pre-April 2020 NHR have tax-free pension income and those who applied later still enjoy a flat 10% rate.

How your pension is taxed as a normal resident is dependent on the type of pension and its source. Generally, they can either be taxed at the scale rates of income tax, treated as long-term savings or an annuity. This taxation can eat heavily into your spending power, so it might be worth rearranging your pensions for better tax efficiency.

Feel free to contact us if you would like to better understand how you can position yourself for your new life in Portugal.

Is there tax relief in Portugal if I am downsizing my home?

By Mark Quinn - Topics: investments in Portugal, Portugal, Property in Portugal, Tax in Portugal, Tax Relief
This article is published on: 27th January 2022

27.01.22

As I covered in a recent blog post, capital gains tax is charged on the sale of all property sold by a Portuguese tax resident, irrespective of where the property is located, or if it was your main residence or not. Capital gains tax is also payable by non-residents who sell property located in Portugal.

To briefly recap the rules:

  • If you are a Portuguese tax resident and sell a property located in Portugal, capital gains tax is payable on 50% of the gain. This amount is added to your other income for that tax year and is taxed at the scale rates of income tax (14.5%-48%). If the property was held for more than 2 years, inflation relief is given
  • If you are not resident in Portugal but you sell a personally owned property in Portugal, 100% of the gain is taxable at 28%. If the property was held in a non-Portuguese company the rate is 25%, or 35% if the company is based in a backlisted jurisdiction
  • If the property sold was purchased before 1st January 1989, no capital gains tax applies

Despite the potential for high taxation, if the property sold was your main home there are two reliefs you can take advantage of to reduce or eliminate your tax bill:

  • Reinvest the net sale proceeds into another main home in Portugal, or EU/EEA;
  • Reinvest the net sale proceeds in an approved long-term savings plan or pension; or
  • Use a combination of the above 2 options. This is useful if you wish to downsize

Any portion not used to purchase another main home or not reinvested in a savings plan/pension will be taxed.

In order to qualify for the reliefs there are certain hoops you will need to jump through. Let’s look at each in turn.

If you choose to reinvest the proceeds in a new main home:

The property sold must be your main home.

  • You must purchase your new home within a certain time frame. This is a period of 5 years; 24 months before the sale of your previous home and 36 months after the sale
  • You or your family must occupy and live in the new property within 36 months of the original sale
  • The new home must be in the EU or EEA
  • The new home must be real estate, this can include land for development. It cannot be a boat or caravan
  • You must declare the necessary details on your annual tax return. It is best to work with your accountant to ensure this is done correctly as the reporting will be over several years unless you sell and repurchase property in one single tax year. If not done correctly, you will lose the relief

The above is all well and good if you want to buy a new property valued at the same price as the property you sold, but what if you do not?

tax relief in Portugal

The Portuguese government introduced a relatively new relief allowing you to reinvest the proceeds, or a part of the proceeds, in a long-term savings plan or pension rather than another property. Again, there are certain rules in order to qualify, but this can be a particularly advantageous option for those wishing to downsize.

The main conditions for qualification are:

  • On the date of transfer of the property the taxpayer, spouse or unmarried partner is in retirement or is at least 65 years old
  • The investment into the structure is made within six months from the date of sale
  • The property sold is the main home
  • Withdrawals from the structure are limited to a maximum of 7.5 % p.a. of the amount invested
  • You must declare your intention to invest the funds in such a structure on your tax return in the relevant year

Whether a pension or a long-term savings plan is right for you will depend on your personal circumstances and the structure must qualify in order to obtain the tax relief, so it is important to take advice.