The Lifetime Isa: three ways to invest

I stare at my screen with mixed feelings. I can’t quite believe the sum now sitting in my Lifetime Isa: over £10,000. I’m proud that I have managed to squirrel away so much in two years. But I also feel daunted. All that money, sitting in cash, doing nothing. What next?

Welcome to the world of the young “Lisa” investor. Since its launch two years ago, the Lifetime Isa has opened a new financial avenue for thousands of young people like me. If you’re aged between 18 and 39, you can use the Lifetime Isa to save or invest up to £4,000 a year. You’ll then receive a 25 per cent annual bonus from the government on whatever you put away to help fund your first home or later life — all free of tax.

But it has not been without controversy. The Lisa has been labelled by some as little more than a taxpayer-sponsored trust fund for wealthy families. It was recommended for the scrapheap by MPs last year, and is only offered by a minority of providers. The complex rules surrounding how the product can be used are also off putting.

Nonetheless, 286,000 people have signed up since its launch in April 2017, including me and my musician brother Matt — young professionals on middle incomes, trying to manage our money for ourselves.

Many use the Lifetime Isa to save for a first home, but as we already own a flat together, we intend to use our Lifetime Isas as a long-term investment — although we have very different risk appetities. FT Money has assembled a team of experts to assess the various options available.

Pension — or property?

The Lifetime Isa bonus of a maximum £1,000 per year has great appeal for young investors — it’s a tangible incentive to take ownership of our long-term finances. That’s crucial because my brother and I are both freelancers. Britain’s growing self-employed population faces a retirement funding timebomb, as automatic enrolment into workplace pensions only applies to full-time employees.

Although you have to be under 40 to open an account, up until the age of 50, you can still pay in up to £4,000 per year and receive the bonus on top. Just like a stocks and shares Isa, investments within the Lisa grow tax free, and there is no tax to pay on dividends or withdrawals. The biggest restriction? Investors cannot take any money out until they reach their 60th birthday. 

Nevertheless, the bonus, the tax advantages and the ability to access tax-free cash at 60 — possibly a decade before we receive our state pension — mean the Lisa is a no-brainer for us.

There’s one important caveat. If you work for a company that matches contributions into a pension scheme, this could well be more valuable than the Lisa bonus — a fact the Lisa’s critics are keen to shout about. 

Those using the Lisa to save for their first property have additional rules to be aware of. For starters, you must be a first-time buyer, the property you buy must be worth less than £450,000 and it cannot be used for buy-to-let. If you buy with another first time buyer, you can combine your Lisa bonuses. If you buy jointly with anyone else, only your bonus can be used.

If you want to take money out before you buy a property, or turn 60, then you will be heavily penalised (unless you are terminally ill). There is a 25 per cent penalty on any withdrawals — effectively a net penalty of 6.25 per cent. It’s cheaper than borrowing in a worst-case scenario, but hardly ideal.

You also have to choose between a cash or stocks and shares Lisa. Conventional wisdom suggests that people saving for their first home should leave the stock market well alone, as they won’t be invested for long enough to ride out the market rollercoaster. But high rents and subdued wage growth mean young people must save for much longer to get on the property ladder — typically at least 10 years across the UK, rising to 15 years in London according to Hamptons International.

Although the bonus is generous, interest rates on cash Lisas also leave a lot to be desired (see table). The financial app Moneybox has recently launched the market-leading cash Lisa paying 1.4 per cent. But that only amounts to an additional £56.36 in interest after the first year if you save the full £4,000.

For now, Help to Buy Isas offer higher rates on cash — but there is a smaller bonus, and they close to new customers in November. 

Could this be tempting more under-40s to risk investing their house deposit fund? 

Research by the investment platform Hargreaves Lansdown suggests a third of its Lisa customers are investing for their first home — that’s around 18,000 people on one investment platform alone.

Sam Ferris is a 25-year-old PR executive from Manchester who moved to London for work. He opened a stocks and shares Lisa to build a house deposit and maximised his allowance in the first year. “I think investing is a reasonable strategy for a first home. You are supposed to invest with a five-year horizon but if there is risk, I am willing to take it.”

However, worries are creeping in. “In the future, I might want to settle down with someone I meet in London. By that point, most properties could cost more than the Lisa’s £450,000 price cap.” But moving back to Manchester would mean uprooting his whole life and career.

He describes the three choices he faces: “Either leave it in there, because I can’t use it for the deposit, which defeats the purpose; withdraw it and pay a punitive fee, or buy a property I don’t want just to access the money. None of these options seem appealing.”

The Treasury says it is keeping all aspects of the Lisa “under review”. In the meantime, Sam has invested 60 per cent of his portfolio in low-to-medium risk passive funds and 40 per cent in small-cap funds focused on Asia, Europe and the US.

“I did a lot of research, but I still found it daunting,” he says. “Most of my friends don’t even know about the Lisa and my parents can’t discuss things in detail — they have a financial adviser.”

A fellow financial journalist tweeted me to say she was having second thoughts about investing for her first home via a Lisa due to the £450,000 cap. She does concede, however, that there is a world outside London. “Maybe I’ll be able to write from my £200,000 Scottish castle.”

In the meantime, Lisa investors are operating mostly in the dark. Young people like me struggle to access affordable financial advice. To help establish an investment strategy that could suit your own circumstances, a panel of experts has provided guidance for three common Lisa scenarios — someone saving for a property, plus higher risk and lower risk strategies for those who are investing for the long term.

Aiming for your first home within 5-15 years

Most experts thought Sam could take more risk if his homebuying dream was at least five years away. However, Jason Butler, the FT’s Wealth Man columnist, is adamant the minimum investing timeframe should be a decade, if not 15 years. 

“If another financial crash happens, which becomes more likely as markets hit new highs, [young investors] might not only have a lot less to buy a home, they might be scared off investing in the stock market forever.”

It all hinges on a person’s attitude to risk. Laura Suter, personal finance analyst at AJ Bell, advises that you can find questionnaires online to help think this through. “Lots of people overestimate how much risk they are willing to take, so it’s useful to double check how you’d actually react if markets fell and your savings pot dropped too,” she says.

The last financial crash wiped nearly one-third off “moderately risky” portfolios, according to Wayne Berry, investment manager at Brewin Dolphin. “If Sam had the ability to ride out a similar trough in future and didn’t need to buy immediately, he could [have to wait several] years for his investments to recover,” he says.

Keeping all or part of your savings in cash may be a better option, says Bella Caridade-Ferreira, chief executive of research firm Fundscape. 

Help to Buy Isas offer better headline rates of interest — Barclays pays 2.58 per cent. While both accounts offer a 25 per cent bonus on your savings, this is limited to £400 per year on Help to Buy Isas against the Lifetime Isa’s £1,000. 

It is still possible to open a Help to Buy Isa, but you need to act fast — they close to new savers on November 30. If you’ve opened one, you can continue to pay in until 2029 and have the option to transfer to a Lisa in future. 

For those who invest using the Lifetime Isa, it is possible to leave part of your portfolio in cash but the rates of return will be derisory.

To beat the returns on cash, you will need to move up the risk curve. Experts say multi-asset tracker funds are a good place to start. Easy and low-maintenance, they will spread your risk across different assets while keeping your costs low — you don’t want to let high fees erode the value of your pot.

Many experts mentioned Vanguard’s LifeStrategy range — a “one-stop shop” from he US tracking group that offers a blend of hundreds of portfolios pegged to equity and fixed interest indices in a single investment. There are different “strengths” available — the higher the percentage in equities, the riskier (and potentially more rewarding) the returns could be. 

Ms Caridade-Ferreira says: “The ongoing charges [0.22 per cent] are very low, giving you the edge over similar funds and making it a sound long-term option.” Sam could opt for one with 60 per cent in equities and 40 per cent in fixed income, or vice versa to play a bit safer.

Compared to cash, Mr Berry reckons that a portfolio weighted 65 per cent towards equities and 35 per cent towards fixed-income and cash could generate an annual return of 6 per cent, based on 10-year average performance after costs (note the word “could”, not “will”).

Sam invested his £4,000 allowance in one tranche last October — just before markets sank to their lowest point in eight months. For this reason, Ms Suter recommends setting up a regular investment plan to drip feed £333 per month into the Lifetime Isa instead: “It helps to avoid attempting to time the markets, which even professional fund managers struggle to do consistently.”

Bear in mind that you will have to invest the 25 per cent bonus manually, which will be paid after four to eight weeks. Most investment platforms will automatically put it in a cash holding account. 

Investing for retirement with a low-risk appetite

The experts all understood why my musician brother Matt was a nervous investor, but gently encouraged him to be a bit braver. 

“If you’re starting in your thirties, the money will be locked up for three decades or more, meaning you can afford to ride out the highs and low of the markets,” says Ms Suter.

Patrick Connolly, chartered financial planner at Chase de Vere, says all long-term investors should start at the higher end of the risk spectrum and move down as they approach retirement in order to protect their funds. For many first-time investors, using a robo platform will appeal — within a few clicks, you can assemble a portfolio of ready-made investments built around your risk appetite. This is an easy way to get started; the chief downside is that investment charges may be higher. 

Alternatively, Mr Connolly suggests that low-cost tracker funds are the cheapest building blocks — for example, the HSBC FTSE All-Share index charges just 0.07 per cent — but investors need to decide how best to allocate their portfolio.

As well as balancing exposure to shares and bonds, Ms Suter stresses that investors should not fixate on the UK, and think global — it is possible to invest in trackers and exchange traded funds (ETFs) that replicate pretty much every stock market in the world, with some devoted to global equities.

Cautious investors could also consider allocating a small part of their portfolio to investment trusts or actively managed funds discussed in the next section. 

Ms Suter says investors can check they are not overpaying for “closet trackers” (active funds that charge high fees, but mostly copy indices) by consulting the thrillingly-named Key Investor Information Document (KIID), which comes with every fund online. 

Finally, for freelancers who are basic rate taxpayers, the Lifetime Isa is a great start — but despite the name, experts stress it should not be your only form of retirement saving. Higher rate taxpayers could be better off saving into a private pension, as they will get 40 per cent tax relief on contributions, almost certainly beating the Lisa bonus. If you work for a company, the same can be said about pension contributions from your employer.

Investing for retirement with a higher-risk appetite

While I’m happy to be more adventurous, Mr Connolly warns against being too gung-ho. “You need to get the balance right between funds that provide good long-term returns and diversification while also keeping an eye on charges.” To that end, I could also use low-cost trackers in my Lisa portfolio, but increase my exposure to equities, and consider allocating a significant chunk to active funds and investment trusts.

Active funds — where you pay a fee to a fund manager to pick a basket of stocks — have a chequered reputation. The majority fail to beat the market over the long term, boosting the appeal of cheap trackers. But there are certain funds with an unquestionably strong record such as Fundsmith Equity, overseen by Terry Smith (with an ongoing charge of 1.05 per cent).

Ms Suter suggests Lisa investors could look to add active funds on top “to build up a bigger portfolio once your investment pot grows”. She proposes a portfolio of 5-10 funds spread across different asset classes and regions. The hope is that these will get you a better return over time than tracker funds, but it’s far from guaranteed — investors need to do their homework. 

As I have a 30-year investment horizon, experts suggest I should focus my research around particular themes.

Sectors thought to have long-term promise at the moment include technology, healthcare and renewable energy, according to Andy Parsons, head of investments at the Share Centre. “You should spread your £4,000 annual Lisa allowance across a number of the areas mentioned and if you have any extra funds, use up your remaining £16,000 stocks and shares Isa allowance,” he says. 

Ms Caridade-Ferreira suggests exploring funds focused on global small-cap stocks, such as Baillie Gifford Global Discovery. This invests in small, entrepreneurial companies that, as she put it, could become “future leaders”. It has an ongoing charge of 0.77 per cent. 

She also notes the growing popularity of investments with a more ethical flavour. The Royal London Sustainable World Trust aims to “mitigate environmental and social challenges and improve quality of life” but has high ongoing charges of 1.52 per cent.

Ms Suter says younger investors should not neglect income-producing funds, which target mature companies that pay investors a dividend. She says I could automatically reinvest the dividends paid out by a fund like Evenlode Global Income — with underlying holdings such as Unilever and PepsiCo — by buying the “accumulation” share class.

Emerging markets have seen wild swings in sentiment, but Mr Connolly reckons this is where the selection services of an active manager can pay off. One he rates is the JPMorgan Emerging Markets Trust, which charges 1.09 per cent.

The investment trust model has lots of pluses, such as an independent board and an emphasis on long-term investment. As investors buy shares in the trust, rather than units in a fund, check the trading fees your investment platform charges. 

Finally, Mr Berry says that while a portfolio containing higher-risk investments could “reap significant rewards” I will also have to invest more of my time keeping an eye on it. “You’ll have to revisit it to ensure it's not too volatile.”