This thought piece explains why it’s so compelling to fill your ISA each year. The approaches discussed won’t be suitable for all readers! Please think about your own situation and get professional advice if needed.

Even on a good middle-class income, it’s not easy to fill your ISA. The annual ISA allowance – £20,000 per year per adult – is pretty chunky.

And that’s a shame, because the ISA is a near-peerless tax shelter.

Gains made and income received in an ISA are tax-free. They don’t use up other tax allowances. You don’t even declare them on your tax return.

The snag is the ISA is a use-it-or-lose-it allowance. If you don’t fund your ISA one year, then that year’s allowance is gone.

That is to say, there’s no ‘carry-back’ type option, in contrast to pensions. 

Use it or lose it

Even with no investment gains at all, you can squirrel away £500,000 into ISAs over 25 years. Just by putting in the maximum of £20,000 annually. 

Okay, so ‘just’ is doing quite a lot of heavy lifting in that sentence. You would be excused for not quite being able to rustle up twenty grand of post-tax spare cash, year in, year out.

Especially in the early years of your career when your earnings are low, or when you’re trying to save for a house deposit. Or when you’re servicing a mortgage or wanting to go on holiday, or paying the school fees. Or for the kids’ university.

Oh, and what about saving into your pension?

Suddenly that difficult year is looking like your whole career. 

But then Great Auntie Mabel goes and dies and leaves you £500,000. (She bought a house in 1976.) It’s a shame you can’t just put that all into your ISA in one go, isn’t it? 

Especially since a friend, whose Aunt Bessie gave them £20,000 a year conditional on it being kept in a cash ISA during her lifetime, got exactly the same inheritance. Only they get a tax-free income from it, in perpetuity!

Tax and spend

Let’s say you both invest your inheritance into corporate bonds paying 2.5% per annum.

Let’s also presume you’re both higher-rate taxpayers in your retirement.

Because your windfall remains outside of an ISA, you will have £5,000 less to spend from your inheritance every year than your friend:

• £500,000 * 2.5% * 40% tax = £5,000 tax

And since the ISA allowance is now effectively inherited between a couple when one of them dies, the ISA tax shield benefit could go on for 30 or more years. Which means the ‘cost’ of not being able to use that ISA allowance might be £150,000 (each).

And that’s all assuming no growth.

Yes yes, I know, you could be putting the inheritance into your ISA over this time, and at year 20 you’d have it all in there. My numbers are to illustrate a point.

Besides, perhaps you’ll get a second inheritance or a bonus or sell a buy-to-let, or some other windfall?

Gimme shelter

It all seems a bit unfair. It’s like the full ISA tax break is only really available to those who start out rich in the first place!

If only there was a way to carry forward all those unused years of allowance to later on in your life…

As I just alluded to, a later life windfall might not even be an inheritance.

Many people earn much higher wages in their 40s and 50s. Or they might cash-out equity in a business they are involved in. Or sell their Bitcoin.

Whatever the case, it would be nice to be able to shelter any late-life lump sum in the ISA that you couldn’t afford to fill in your 20s, wouldn’t it?

Well if you haven’t ‘banked’ all those decades of allowances, you can’t.

Should you borrow money to fill your ISA?

Borrowing to fill your is ISA is the classic business school solution to this conundrum.

Every year you borrow £20,000 and put it into your (cash) ISA.

When Auntie Mabel dies you’ll have £500,000 in your ISA and £500,000 of debt. Her money pays down your debt leaving you in exactly the same position as your friend.

Voila!

Common objections include:

• Who’s going to lend me that sort of money?
• The cost of the debt will exceed income on the cash ISA. That makes this an expensive exercise for some uncertain future benefit.
• Shouldn’t I buy equities in the ISA for higher long-run returns? 

All reasonable counters. Let’s get the last one out of the way first. You’re asking should you borrow to invest in risk assets? That’s a different question to the one we’re answering here. We’re just going to say ‘no’ (for now). 

To answer the first two objections, we turn to our secret sauce – a devilish brew of Flexible ISAs and offset mortgages. 

Your new flexible friend

Flexible ISAs enable you to withdraw money from your ISA, without it affecting your allowances, as long as you return it in the same tax year. In this case it is treated as not having been withdrawn at all.

The legislative intent behind this is to enable you to use your ISA cash to meet unexpected large expenses and then ‘return’ the money to the ISA.

But we don’t care about the intent here. We only care about how we can turn this to our advantage.

Fill your ISA every year

You can withdraw money on the morning of the 6th April 2021 – the first day of the new tax year.

As long as it’s back in the ISA by the evening of the 5th of April 2022, very nearly one year later, you’re in the clear, because you’ve returned it in the same tax year, haven’t you?

Of course, the next day you can take it back out, for nearly a whole year again:

And you can do this every year – ‘re-paying’ into the ISA all the previous years’ used allowances, plus this year’s, and then immediately withdrawing it all the next day. 

We only need to borrow the money for one night every year – overnight between the 5th and the 6th of April.

Now we’re going to need to borrow an additional £20,000 more each year for that evening, which may present challenges.

And realistically we should get it there a few days early, as opposed for just one day. There are operational risks – think “computer says ‘no'” hiccups – when moving large amounts of money around. 

Off and on again

But how will you borrow the money?

That offset mortgage, of course.

If you have an offset mortgage or a flexible mortgage (one that enables you to overpay and redraw funds at will) then you’re all set.

You’re simply going to draw the money down on the 5th, warehouse it in your ISA overnight, and then pay-back (or offset) the mortgage with it for the other 364 days of the year. It’s only going to cost you a few days’ interest.

True, you might need to start off by taking out a larger mortgage than you would otherwise require, in order to give yourself the borrowing capacity to fill your ISA. But since it’s an offset / flexible mortgage, you can do that and pay no more interest, since the extra cash will spend most of the time parked against your outstanding balance. 

This is a completely reversible transaction. It’s not like contributing to your pension, say, where the money is locked away. You can stop at any time if you need to, and let your ISA allowance lapse.

And it’s a very low-cost option. 

Variations on the theme

This is just an idea. Do with it what you will. And yes, there are many real world frictions.

But it doesn’t have to be all or nothing – and you don’t have to do it for 25 years.

Maybe you only do this with a portion of your ISA, because you can afford to save some money from your income, too? You borrow to top-up the rest.

Or it could be as simple as avoiding the difficult decision of whether to use your bonus to pay down your mortgage or use up your ISA allowance. Do both!

Perhaps you could do a 0% transfer on your credit card balance, free up a bit of cash for a few months, and use it to fill the ISA allowance this year.

Business owners may be able to borrow from their business without tax implications if it’s within the company’s fiscal year (a reason for not having a April 5th end-of-year).

Crypto bros can DeFi borrow against their Bitcoin for a few days without triggering capital gains tax on their BTC. 

You get the idea.

What about pensions?

The pension annual allowance is another, somewhat, use-it-or-lose-it allowance. (Only ‘somewhat’ because there exist carry back / forward arrangements).

But you can’t get access pension money very easily, so borrowing to fill it is a very different proposition.

However, there may be edge cases where it’s worth considering, such as if you’re a 60% tax payer (earning £100,000 to £125,000) on the eve of retirement, and a long way from the Lifetime Allowance.

The point is to be – cautiously and legally – creative.

Nobody else is better at looking out for your money than you are!

If you enjoyed this, you can follow Finumus on Twitter or read his other articles for Monevator.

What caught my eye this week.

For as long as I’ve been conscious of what’s happening beyond my own digestive tract, London was on the up-and-up.

From the 1980s yuppies I caught the tail-end of in the early 1990s and the regeneration of Docklands, to the middle-classing of the East End, the Dotcom bubble, the 2012 London Olympics, and the pre-Brexit immigration boom at both ends of the jobs market – London was where it’s at.

Of course, it wasn’t all rosy. House prices are up as much as 10-fold since I’ve been here. That long ago priced out most of those without parental help or huge salaries. Many London-born left the city altogether.

Also, despite all the wealth generation, some of the most deprived areas of the UK are still in London. Admittedly this has eased in recent years. But that’s perhaps as much because of gentrification as the locals getting richer.

Indeed, while the tidying up of London has suited my hipster tastes for flat whites, farmer’s markets, and retro beats, I’m not sure it was all good news.

Something was lost. London is less village-y now than when I came here from a real village in the provinces. Different boroughs have mostly the same shops, style, and people.

Though I suppose that’s happening everywhere.

The big smoke

Talking of everywhere, some readers complain when I focus on London every year or three in an article.

This reflects a wider sentiment – that London gets too much attention, and that we long had it too good in this city. (Though ironically, most of those who moan about London’s riches also say they’d hate to live here).

They feel aggrieved despite London being a net contributor (via its trade surplus and redistribution) to the UK economy.

And despite London being realistically the only place in the UK with the status to pull in enough foreign capital and talent to really move the dial.

Such regional resentment was one of the many motivations behind the unfortunate vote to leave the EU in 2016.

Yet despite the odd protest, I will continue to single out London occasionally, so long as I’m blogging.

London calling

London is my home, for a start. (Nobody minds when Ermine wanders about in the Somerset countryside or Dave has a run in the Highlands!)

Nearly a third of visitors to Monevator are in London, too. The three nearest web traffic rivals – Glasgow, Manchester, and Birmingham – account for only roughly 2% each. Besides the sheer population size, there’s a fit between our content and Londoners that definitely isn’t exclusive, but is pretty natural.

Also London makes a unique contribution to the UK economy. I have sympathy with the view that it’d be nice if it wasn’t so. But anyone seeking to change this is fighting a global trend. Or at least the pre-Pandemic trend.

Personally, I believe we should all be grateful the UK has (had?) one of the handful of world class cities, even as the economic centre of gravity shifts to Asia.

Home alone

Others will disagree. They’ll be heartened by this heatmap showing that while the housing market in England is on fire, London isn’t:

London house prices are still very expensive, despite years of flat-lining. So maybe they shouldn’t be rising. But property is soaring globally on low interest rates and the fallout from Covid, so something is going on.

It’s probably too soon to unpick the impact of the UK’s self-harming Brexit on London from the consequences of the pandemic.

Foreign-born workers have returned home for both reasons. And plenty of UK residents have moved home to outside the capital – or said they’d like to – now they don’t have to enjoy the supposedly gilded life of a Londoner squished into a tube at 7am to pay for a one-bed flat above a train station.

I haven’t yet decided whether widespread working from home – or at least not in the office – is a fad, or the new normal.

The City of London is still ‘fairly empty‘. London-based workers in general want more pay to return to the office. Only a minority are in a hurry:

With Covid-19 restrictions leaving many offices empty, white-collar staff have spent 16 months mostly working from home.

Just 17% now say they actively want a full-time return to the office [research shows].

The City of London Corporation has already started planning to redevelop excess office space into residential homes.

But when the big idea of the summer for making London a better place to visit and live was a £6million mound of earth, more might need to be done.

We’re shafted, or we’re Shaftebury-d

On balance I’m a bit more pessimistic about a full-blown return to office life than I was. (I mean pessimistic from an investing standpoint. I don’t think a five-day workweek in an office is particularly healthy!)

As a result I sold some early post-pandemic investments I made into quoted commercial property companies that owned mostly generic office space.

But I’ve hedged my bets with a position in Shaftesbury PLC.

Shaftesbury owns swathes of London’s West End – Soho, Covent Garden, Chinatown, and Fitzrovia. I believe you’d need much more money than the firm’s depressed valuation if you wanted to recreate this asset base.

I also judge that with a focus on leisure and destination shopping and the coming of the much-delayed Crossrail connections, if these areas don’t bounce back in the next few years then everything really has changed.

Normally everything doesn’t change. Time will tell.

Are you placing bets on the future of London, or the UK in general? Let us know in the comments below.

And have a great weekend!

[continue reading…]

The 10-year returns are in for the Vanguard LifeStrategy funds. Forget the birthday celebrations and keep your cake, I hear you cry. Just tell us did the passive fund-of-funds deliver?

• Did LifeStrategy investors earn respectable returns over the last decade?

• Did the passive fund family hold its own against active funds that promise to beat the market like a drum?

Well, without wanting to spoil the surprise… if you invested in any of the Vanguard LifeStrategy funds a decade ago then you can be quietly pleased with yourself today.

Vanguard LifeStrategy 10-year returns

Here’s the 10-year returns for the entire Vanguard LifeStrategy range:

Source: Trustnet. Nominal1 annualised returns to 19 July 2021

Ten years ago, a LifeStrategy 100% investor might have hoped for around 7.5% annualised over the next decade (assuming they added average long-term inflation of 2.5% to an average historical equity real return of 5%.)

But expected returns were typically more pessimistic back then. For instance, the Financial Conduct Authority had recently published a real2 expected return range of 2.6% to 3.8% for a 60:40 equity:bond portfolio.

Call that 5.1% to 6.3% in nominal annualised terms.

As it turned out though, Vanguard’s LifeStrategy 60% bagged 8.4% annualised returns over the last decade.

Maybe there’s time for a slice of that cake, after all?

Risk versus return

The table above also shows the price paid by cautious LifeStrategy investors during a decade of high equity returns.

Each 20% allocation to bonds rained on the returns parade as surely as a low pressure front hovering over your BBQ plans.

The 10-year cumulative returns show most clearly what you had to give up in exchange for lowering volatility:

Source: Trustnet. Nominal cumulative returns to 19 July 2021

Still, a wince now beats the pain of panicking and selling out during a market bloodbath to come.

I’m not going to dwell on the risk-reward trade-off. The fact is a 100% equity allocation is not to be taken lightly. It is definitely not for most people.

Most of us will do better to be happy we enjoyed one of the all-time bull runs and maybe draw a few conclusions about the future. Such as that our past good fortune does mute the market’s prospects for the next decade.

With that said though, it’s arguably the bond-packing funds in the Vanguard range that have covered themselves in glory, not LifeStrategy 100%.

Yes, the equity-only LifeStrategy fund has done a solid job. But it hardly shot the lights out for the extra risk, compared to say LifeStrategy 60%.

LifeStrategy 100% returns vs the Rest Of The World

Vanguard LifeStrategy 100% is comfortably mid-table versus other geographic bets you might have made a decade ago:

Nominal annualised returns to 16 July 2021.

The real comparison here is between the iShares MSCI World ETF and the LifeStrategy 100%. You could have plausibly chosen either option ten years ago to gain cheap exposure to globally diversified equities.

As for the other funds, they help illustrate which regions flourished and why that cost the Vanguard fund.

Home bias – that is, an extra dollop of UK equities compared to a true global tracker – bit LifeStrategy investors over the last decade.

The LifeStrategy 100% fund is 22% in UK equities. Not helpful in light of the London market’s laggy performance over recent years.

In contrast the MSCI World tracker held less than 10% UK equities in 2011. That allocation is below 5% now.

The MSCI World also excludes the emerging markets.

Instead, you got an extra shot of US equity espresso in your portfolio vs LifeStrategy.

So if you ignored all the advice last decade that US equities were overvalued – congratulations!

But if your next move is to double-down on the US then you’re a braver soul than I.

S&P 500 valuation levels have passed eve-of-the-Great-Depression base camp and are closing in on dotcom bubble peak.

Strategy versus tactics

On the upside, Vanguard LifeStrategy 100% still beat its investment category benchmark, according to financial data shop Morningstar.

Morningstar gave the fund its Silver award – which ranks it in the top third of its peer group, including active fund managers.

Yet the point of LifeStrategy funds is to be a portfolio in a box.

One buy gets you all the diversification you need, including defensive bonds.

So a better comparison pits LifeStrategy 60% against a classic 60:40 equity:bond portfolio.

LifeStrategy 60% returns vs the Rest Of The World

And the bad news is that LifeStrategy 60% lost out to a passive 60:40 portfolio.

I compared the Vanguard fund-of-funds to a simple two-fund portfolio using ETFs that were available in 2011.

Cumulative returns for the last 10 years were:

• 125% Vanguard LifeStrategy 60%
• 158% iShares Core MSCI World / iShares Core UK Gilts

(60:40 portfolio data from justETF)

Home bias is my prime suspect again, but I admit I haven’t dug into the differences in bond holdings, fees, or rebalancing. (I’d shoot myself in shame – if I wasn’t so passive.)

Life is the name of the game

Now for the good news!

LifeStrategy investors can stop beating themselves up because every fund bar LS100% is the holder of a Morningstar Gold award and five-star rating.

• A gold badge means the fund ranks in the top 15% of its peer group for returns after fees.

• Five stars means the fund delivered top 10% risk-adjusted returns in its category over the last 10 years.

Note: This is all according to Morningstar’s methodology and category definitions.

LifeStrategy 60% ranked as high as the 4th percentile in its peer group in 2016:

Morningstar. Vanguard LifeStrategy 60% – percentile rank in category (2014 – 2021).

It’s also important to emphasise that the LifeStrategy funds have trumped the majority of their actively managed peers.

Granted, we can all easily find a handful of active funds that smashed the last decade.

But the trick is to find them in advance. Wisdom after the fact is self-satisfaction dressed like a hipster.

Chart attack

LifeStrategy 60% investors can also enjoy this Morningstar chart of their fund trouncing various benchmarks:

And here’s the Vanguard fund pounding its multi-asset rival – BlackRock Consensus 60:

Note: The comparison begins from the inception date of the BlackRock Consensus 60.

I score this as a triumph in the age-old morality tale of simplicity versus complexity.

The BlackRock Consensus funds’ USP is they hold index trackers with an active management tactical twist.

It turns out we don’t need it, going on the results so far.

Getting on with life

What do 10-year returns tell us? Nothing about the next ten, sadly.

Still, I think the LifeStrategy returns are power to our passive investing elbows.

We’re told to invest for the long-term. But it’s hard to stay true for decades. Especially when we’re battered by outlier success stories all the livelong day. Sometimes it can feel like we’re extras in someone else’s virtual reality bliss machine.

So I think it’s worth celebrating that ordinary investors can get a fair shake just by choosing a simple, well-designed fund that saves you a ton of time and worry.

Take it steady,

The Accumulator

1. Nominal returns include inflation. [↩]
2. Real returns are net of inflation. [↩]