FOOL'S EYE VIEW
Terrific Ways To Invest

By Cliff D'Arcy
October 7, 2004

One of the major downsides of investing is when you buy assets (such as property, shares or bonds) and end up selling them for less than you paid for them. After all, the whole point of investing is to increase your wealth over time, not make losses. But, to be honest, even the most successful investors slip up now and then.

So, what can you do to reduce the chance that you'll make a sizeable loss? You could diversify your portfolio, which means spreading it across different assets (or, with shares, different sectors and companies). The idea here is that you don't have all your eggs in one basket – and end up with egg on your face when the basket breaks!

You could try buying under-valued assets, such as houses in need of renovation or 'value' shares, in the hope that you can unlock this value over time. However, this approach has the occasional pitfall, too.

So, how would you like to buy shares at only four-fifths of the market price, which means a 20% discount? Or, even better, get them for half the market price, thanks to a 'buy one, get one free' deal? This is easily achievable if you're buying shares in a company that employs you.

UK companies can invite their employers to join any of three Inland Revenue-approved share plans, which were created to allow workers to share in their employer's success. One of these schemes (Company Share Option Plans) isn't open to all staff, so I'm not going to write about it today.

However, both Sharesave and Share Incentive Plans are open to all employees, so here goes:

Sharesave (Savings-Related Share Option Plan)

If your employer invites you to participate in a Sharesave scheme, you should give it serious thought, because the rewards can be handsome indeed! There are around 1,333 Sharesave schemes in existence, with around 2.6 million accounts currently open.

With Sharesave, you decide to save between £5 and £250 a month for three, five or seven years (the average amount saved is £70 per month). At the end of this period, you can choose to withdraw your savings plus a tax-free bonus, or use some or all of your pot to buy shares.

The important thing to note is that you don't have to buy the shares, which you wouldn't do if it wasn't financially sensible to do so. For instance, if the shares had collapsed over your savings term, it wouldn't be wise to buy them at a much higher option price!

I'll explain the whole idea with an example, based on the invitation my wife received this month:

• Share price on 30 September:  £11.90
• Option price:  £9.52 (£11.90 less 20% discount)
• Term:  Three years
• Tax-free bonus: 1.9 monthly contributions.

So, let's assume that Mrs D likes the look of this, and signs up for the maximum £250 a month. After three years, she's saved 250 x 12 x 3 = £9,000. Her tax-free bonus comes to £475 (1.9 x 250), making a total of £9,475.

Three years from now, the share price has gone nowhere and is still £11.90. However, Mrs D exercises her right to buy shares at £9.52, so her company hands over 995 shares (9,475/9.52) and £2.60 change.

Mrs D then sells these 995 shares via her stockbroker at the market price of £11.90, pocketing £11,843.10, including the £2.60 spare change (I've ignored transaction charges - see these special offers from stockbrokers).

So, although her employer's share price has gone nowhere for three years, her £9,000 pot has turned into £11,843, which is growth of almost a third (32%). Nice!

Of course, if the market price was below £9.52 three years from now, Mrs D would take the cash and let her option lapse, leaving her with a tax-free gain of £475. On the other hand, if the shares had climbed to, say, £15, she would make a juicy gain of £5,927.60 – two-thirds (66%) of her original pot.

So, Sharesave is a great way to get into the habit of regular saving, plus you get a tax-free bonus and the chance of making very attractive returns. However, Mrs D won't be responding to this Sharesave invitation, because she's already saving the maximum £250 a month!

Share Incentive Plans (SIPs)

At least 2.3 million employees are able to participate in one of the three main types of SIP:

1. Free shares – employers can give each employee free shares worth up to £3,000 each, free of income tax and National Insurance Contributions (NICs).
2. Partnership shares – employees can use up to £1,500 a year from their pre-tax, pre-NIC pay to buy shares.
3. Matching shares – employers can give up to two matching shares for every partnership share that an employee buys.

I'm going to look at option 3, matching shares. Again, my wife is my guinea pig!

My wife's company allows her to save up to £125 of her pre-tax, pre-NIC pay to buy shares, which they boost with a 'buy one, get one free' (BOGOF) offer. (These free shares come with a few strings attached – for example, Mrs D would lose them if she left within three years of the award date.)

In Mrs D's case, saving £125 of her pre-tax income reduces her pay packet by just £73.75. Thanks to the BOGOF, this £125 buys shares worth £250. So, on day one, she makes £176.25, which is an instant return of 239% (176.25 / 73.75).

This 'Share Reward' scheme means that my wife's employer is effectively giving her an extra £2,115 a year (176.25 x 12), which helps to strengthen her commitment to the firm. Together with the Sharesave scheme and generous pension contributions, her company is paying her many thousands of pounds on top of her wage. Her employer does this to encourage loyalty among its staff and, in her case, it certainly seems to be working, as she's worked there for over fifteen years!

Note that, with simple tax planning, it's possible to dispose of shares acquired through a Sharesave or Share Incentive Plan without paying capital gains tax. With my help, one of my friends cleared a tax-free profit of over £40,000 from a five-year Sharesave that mature a few years ago. Tasty!

So, if your firm invites you to contribute to a Sharesave or Share Incentive Plan, remember that the generous incentives and tax benefits make it a no-brainer for most career employees!

More: Check out the fantastic special offers in our Broker centre | Grab A Windfall From Work.

Many thanks to Proshare for providing data for this article.