VCTs for Financial Independence Part 4 – my own experience over 7 years

In this post, I’ll cover GFF’s own performance of VCTs in the 7 or so years that I’ve been investing. How did VCTs compare to other investments, how did they perform during the Coronavirus crash and just how risky are they?

Welcome to the final part of my guide to VCTs. In Part 1 I covered the introduction, Part 2 how to buy/hold/sell VCTs and in Part 3 a practical guide on how they may be used for Financial Indepenence. With any financial product, you should know what you are getting yourself into. Don’t be allured by the big upfront tax relief – especially from providers who aim to skim most of that their way and lose you money. As a rule, you should always balance risk and reward. VCTs are not something you should put your life savings in and they are not for widows and orphans. Furthermore, don’t let the tax tail wag the investment dog!

How it all started

I became interested in VCTs around the year 2007 as I was not enjoying paying so much tax on my income and by saving monthly, I was building up funds to invest. I used to read the Money section of the papers like the FT, Time and Telegraph – man I was so cool back then. I had also found out about FIRE or more importantly worked out that work doesn’t make you happy and it would be best to come up with an escape plan. So, I lived frugally, saved money by not having a car and being a cheapskate basically. It was that saving back in those days when I was young, free, single and solvent that put make my position a bit different from most people at the same age and the money has only just kept growing – so £300 a month saved on not having a car for 5 years means I’ve an extra £50,000 to my name.

With great savings come great temptations

I’ve always had a large slush fund of money to invest where I like – I’ve dabbled with stocks, shares, P2P, offset mortgages and so on. I was able to borrow money on my IO mortgage at 2.5% and lend it back to the bank for 5% – funny times eh? Remember though, back in 2007 you could put up to £7,000 a year in your ISA – £583 a month. That’s a lot less than today’s £20,000. So any money left over after your ISA filling needed a home.

Avoiding tax is one thing but it took me until 2011 to open a SIPP (I had a company pension though) and I was paying basic rate tax most of the time (I think) so even the ISA wasn’t of much value.

So, in the end I decided to pay the tax that was due but I remember what bloggers like Retirement Investing Today were saying about counting taxes like spending and thought that I could do something to reduce my tax burden.

My plan was simple: First I used my SIPP to eradicate 40% tax and then used VCTs to eradicate the 20% tax. If I earned £50,000 on a tax year and paid £10,000 tax in total, I would pay £10,000 into the SIPP to save £4,000 tax. The 20% tax on the £10,000 to £40,000 band of income comes to £6,000 and by investing £20,000 into VCTs I’d get it all that back. It seemed really simple really. Having such a high commitment to tax avoidance (£30,000 churned into VCTs/SIPPs on a pre-tax £50,000) could only be done by having the savings from earlier in my life – another example of how having money saves you money.

Starting Off

I had spent a lot of time researching VCTs and which to go for – but looking back I was winging it. I read everything on forums like Lemon Fool (then MF). and copies of the great Tax Efficient Review . I invested first in the well respected British Smaller Companies VCTs, they served me well with cumulative returns of 60% (before tax relief) to date.

Felines see you as prey!

I also invested in a feline themed limited life VCT – “invest for 5 years with us and you’ll get 6% dividends plus your money back” was the promise. They were shit with a monthly NAV that dipped lower and lower and dividends that weren’t covered by capital growth. Return on £1.00 put in was 75p – a loss of 25%, the only saving grace was the tax relief! I was investing in similarly risky investments in my P2P but my return on a similar basis would have been to turn that £1.00 into £1.50. Lessons learnt (except I put money into the next annual feline themed money pit which has returned 50p on the pound but might still have a dividend to come – but the communication has been shit.) Lessons learnt. I did invest in another fixed life investment which turned £1.00 into £1.01 before tax relief which was a disappointment too.

Building my portfolio

As the years went by, I invested in a few different VCTs when they had offers. I never bought on the secondary market but I have purchased via dividends. There are some people who have bought on the secondary market but you need to know what you are doing – and I didn’t.

As any good student of financial risk management will tell you, don’t keep all your eggs in one basket – you’ve got to diversify! And diversify I did. I invested in 27 different VCTs from 13 different houses. Arguably you could ask who I didn’t invest with but this is the risk of diworseification.

In more recent years, I’ve put more money into concentrated holdings in houses/funds that I know a bit about and that have done a good job. Past performance isn’t a guide… I know that but it keeps things easier this way. Also, since VCTs make up a small fraction of my overall net worth – peaking at about 18% but now dropping down to around 10%, it’s not a problem for me risk-wise. Of course, you may feel differently about it from me.

VCT holdings over time

VCT cashflow overtime

One of the attractions for me was the 5 year holding period. VCTs for Financial Independence would mean that I could buy, hold and sell over 5 years. So, after starting slowly, I began increasing my holdings and I topped out at about 18% of net worth, now sitting around 11%. I am comfortable with between 5-15% – they are illiquid investments and the value will fluctuate but I’ve always had our affairs in order to not be caught short of cash. If you aim to invest the difference between your 0% upper limit and 40% lower limit on income tax* and sell after 5 years, you are looking at a VCT position of around £125,000 at any one time. Once you reach 5 years, your holding should be relatively stable, money in = money out and you keep the tax relief. I never saw the point of going after higher rate tax with VCTs as the 30% tax relief is less than the 40% tax – meaning you need to put a lot into them. Also, pensions end up being a much sweeter deal than VCTs which are not as great.

As I pointed out in Part 3, VCTs provide generous dividends that are tax free. My experience over the last 7 years has been that the dividends provide a useful income cushion, especially when I was salary sacrificing as much as I could into my workplace pension, paying for childcare and generally running a deficit on the family budget. Without VCTs, I’d have to have started eating my dividends – which is something I (and most people) want to avoid.

As you can see from the chart below, we’ve received a steady flow of dividends over the last few years. Currently around £10,000 a year, it’s a comfortable sum and should continue into the future.

Performance

I decided to take a look at the performance of my VCT investments and compare them with first the FTSE AllShare total return index, the Greencoat Wind investment trust and the AIM index total return. The comparison does not count buying/selling/spreads on these and platform fees. For VCTs it’s a case of money in less sales/dividends and current selling price value of VCTs. The impact of taxes is also ignored. The chart shows the profit in these different investments including VCTs with and without tax relief.

What you see first of all is that the VCT green line (without tax relief) doesn’t generate much profit over the time. The blue line (with tax relief) shows strong early gains and a consistent increase in profit as time goes by. Most of that profit is from the tax relief. Profit wobbles in 2020 with corona.

Of the comparison investments, Greencoat Wind is the clear winner. If I’d put my money into only that I’d have about £50,000 more. I chose to include Greencoat wind as I would have maybe put more of our money into that investment.

The profit from the FTSE Allshare total return index and AIM both lag VCTs by some margin making me £30,000 better off. I chose the allshare as that’s maybe what I would have invested in and the AIM since this is an index for small companies (like those VCTs invest in).

VCT Performance has been surprisingly stable over the last 7 years. You might think that investing in “risky” business would give you wild swings in prices but you can see from the graph below that performance has actually been less volatile than the FTSE Allshare total return and provided a better return. And whilst the effect of covid was around a £15,000 drop in VCT value, the FTSE Allshare lost over £40,000. This of course is with tax relief included. Without tax relief it’s been a bad investment overall. The lack of volatility of VCTs acutally surprises me and overall performance has not been too bad.

If I knew then what I know now?              

Good question, VCTs have been a solid investment and performance has surpassed the FTSE Allshare. And on that basis, I would say that it’s been worthwhile and I’m glad that I got involved. Should I have bought Bitcoin, Tesla and winning lottery tickets? Yes – but you can’t always predict these things. VCTs has meant a lot more paper work in the family office – share certs, documents, dividends certs and so on and it’s more things to keep any eye on and time to do it. On that note, it might have been better to not get involved but I enjoy the process and maybe it’s the illusion of control that I like – even though most investments I made pigs in a poke. On balance, I think that I would invest again – although avoiding fixed interest and opting for fewer holdings to reduce the paperwork and transaction fees.

Will I invest in VCTs in the future?

For a variety of reasons, I have less tax liability now and less urge to claw some of that tax back. But still, I could invest a bit in and indeed I did so earlier this year. I expect that I might invest again in a select few VCTs which I have experience of or knowledge of. I’m expecting a large flood of VCTs sales in the next 12 months and I’ll need to check our cashflow situation on where that can be put. VCTs as shown in part 3 offer a viable alternative to cash savings or a taxable GIA (especially for higher rate tax payers). I would only look at VCTs once ISAs, LISAs, Pensions and cashflow requirements have all be taken care of AND VCTs don’t make up more than maybe 5-10% of net worth.

Summary of my experience

I’ve demonstrated that investing in VCTs has brought financial success to me and my family. They are not that volatile (despite investing in small companies) and they have a rather boring price performance over time, that makes them less risky than you might think. The downsides of VCTs (namely the high fees, time-consuming buy/hold/sell, poor growth) are outweighed by the overall return which has mostly been from the 30% tax relief – dividends are tax-free and add up to around £10,000 a year for us. I could have done better by investing elsewhere but also they did better than the FTSE AllShare – so it’s easy to pick winners after the race is won. Another attraction as covered in Part 3 is that since I hold onto the VCTs for 5 years, I know that there is future cash coming to us over the next 5 years from selling. So VCTs for Financial Independence are a tool that can help even out cashflow at the start of your next steps in life. And it’s the tax free dividends and that future cashflow that I like about VCTs and why they form part of our family portfolio.

Thanks, GFF

*this gets more complicated (and worse) with Scottish income tax bands.