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20 April 2015updated 22 Oct 2020 3:55pm

How to spend it: why do people put their money where they do?

Where we invest is driven by a mix of personal preference, government incentives and economic trends.

By Andrew Power

Investing habits in the UK change every generation, driven by the underlying returns of various investment instruments, by government and other savings incentives, and by popular perception around the efficacy of different types of investments. So what have some of the latest trends been in key investment areas?


Pensions and ISAs

Even 15 years ago, the majority of private sector employees were covered by defined benefit pension plans. Individuals did not have to worry about where to invest their pensions; it was done for them by their employer, and the individual got a guaranteed income stream.

Nowadays, most companies have closed their defined benefit plans to new members and often to ongoing accruals for existing members. As a result, over the past 15 years active membership in private sector defined benefit plans has fallen by two-thirds. Instead, pension savings are through defined contribution plans where the employer pays a fixed percentage of compensation into the pension plan, and the employee determines where that money is invested and takes on the investment risk. More than 80 per cent of these defined contribution flows go into the default funds offered.

In order to reduce the burden on the state pension system, the government has tried to encourage savings with tax-incentivised savings schemes, of which ISAs are the most prominent. Over time, the importance of ISAs has increased relative to individual pensions due to their flexibility, and ISA rules have generally been made more favourable (in terms of deposit amounts, and freedoms on investments). As a result, more than twice as much money is put into ISAs annually compared to personal pensions.

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The British love affair with property continues. For most, property is their largest source of wealth and surveys show the majority aspire to home ownership, unlike countries such as Germany where renting is much more common. However, inter-generational differences are emerging. Due to the cost of housing, particularly in the south east, and the tightening of bank mortgage lending criteria, home ownership among the under 35 year olds has declined. Meanwhile, the wealthier are increasingly looking to expand into buy-to-let, as the tax treatment is
still favourable.


Post-crash behaviour

The initial response to the financial crisis was for individuals to be more conservative in their investments. However, with the continuing period of low interest rates, people have begun to diversify their holdings. In particular, multi-asset or managed funds have become popular given their higher yield yet relative stability. The wealthier have also looked to increase exposure to alternatives, such as hedge funds, private equity and
commodity funds.

There has also been significant de-risking by many institutional investors, particularly pension funds and insurers, in light of increasing employee longevity and capital/funding requirements associated with holding riskier assets. Given accounting and valuation rules, these investors have increased substantially their holdings of fixed-income instruments in order to minimise volatility, despite the fact these instruments have low (and in some recent cases even negative) yields .


Looking ahead

Going forward, what can we expect to see? Recent changes in legislation around annuities, ISAs and inheritance tax treatment of investments will alter behaviour. Already, with the announcement that “nobody needs to buy an annuity” from this April, individual annuities sales have fallen more than 50 per cent. Further restrictions on pensions’ annual allowances or lifetime limits are likely, given the value of the tax break to higher rate tax payers. As a result, the affluent will begin to look at alternative investments, particularly those that might have tax advantages, such as venture capital trusts (VCTs). Changes in housing incentives from a proposed mansion tax, changes to stamp duty calculations and any introduction of capital gains on primary residence sales will all affect, at least temporarily, the public’s view around property.

Finally, the future path of interest rates and inflation will have a major impact on savings patterns. Higher interest rates will affect how much people can save, given higher mortgage rates will lower disposable income, and will make fixed-income instruments (or even annuities) more attractive vehicles. In contrast any prolonged period of low or negative inflation will see people searching for yield, and perhaps taking more risks than they realise.

Investment and savings patterns are in constant flux with economic conditions. Regulatory and fiscal changes are the biggest driver of shorter term changes in
asset preferences, however, over time, it is the longer term factors that will have the greatest influence. l

Andrew Power is a partner at Deloitte

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