Don’t risk your portfolio by hyperfocusing on tax

The potential for significant fiscal policy changes in the upcoming budget has prompted many investors to focus on tax. This is entirely understandable given there has been seemingly never-ending speculation regarding which taxes could rise and the possible changes to tax-efficient accounts such as ISAs and SIPPs.

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For example, there have been rumours that changes could be made to rules governing tax-free pension lump sum limits. Similarly, it has been widely reported that Chancellor Rachel Reeves may be considering changes to the existing annual ISA allowance.

Known unknowns

However, there is a danger that investors may end up trying to forecast tax changes which are fundamentally unforecastable. This risks having a detrimental impact on their portfolio’s long-term performance.

For instance, some investors may have decided to take 25% of their entire pension as a tax-free lump sum ahead of possible rule changes in the Budget. This could have been worthwhile if detrimental tax changes had arisen. However, press reports suggest the Treasury has recently ruled out making changes to the amount of money that can be taken tax-free from a pension in this year’s Budget.

This means some investors may now be left with a relatively large amount of cash outside their pension that exceeds the annual ISA allowance. They may have little option but to invest it in a less tax-efficient manner vis-à-vis a SIPP.

Unforeseen circumstances

More broadly, putting too great an emphasis on tax considerations may also cause unforeseen challenges. For example, an investor may pay a significant proportion of their income into a SIPP each year as they seek to invest in a tax-efficient manner. While this could ultimately equate to a relatively large pension pot, it will be inaccessible until they are 55 years old (57 years old from April 2028).

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In the meantime, they may require access to more cash than they had previously anticipated. For instance, they may wish to purchase a larger home but could struggle to afford it given that a large proportion of their wealth is tied up within a SIPP. Or they could even require additional capital for medical expenses or other unforeseen items that put them under financial strain prior to retirement.

Limited resources

Of course, every investor has a finite amount of time that they can dedicate to managing their portfolio. If a large proportion of this is being spent on tax considerations, it naturally leaves less time to focus on which investments they hold. This could lead to relatively disappointing investment returns that even potential tax savings struggle to make up for.

At present, this point is particularly relevant. The world economy continues to face an uncertain period, with risks such as elevated inflation and increased protectionism having the potential to cause difficult operating conditions across several industries. Investors should therefore spend time ensuring that their holdings are fundamentally sound in terms of having solid balance sheets and competitive advantages. Such attributes are likely to provide a higher chance of survival, and subsequent recovery, should global economic growth temporarily deteriorate.

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Likewise, investors should ensure they allow sufficient time to check that their holdings still offer good value for money. This is particularly important amid current market conditions, with stocks in some regions, such as the US, trading on exceptionally high valuations and those listed elsewhere, notably the UK, offering far better value for money in some cases.

Indeed, investors who can dedicate a large proportion of their time to combing through the FTSE 100 index in search of undervalued stocks could generate relatively high returns in the long run.

Weir Group

Weir Group (LSE:WEIR) appears to offer long-term investment potential. The FTSE 100 constituent, which provides engineering solutions to mining companies, is poised to benefit from an improving long-term global economic outlook as previous interest rate declines across developed economies, plus potential further monetary policy easing amid a prospective decline in inflation, lead to higher demand for a range of commodities.

The world’s push towards net zero could also act as a positive catalyst on the firm’s financial performance. With renewable energy infrastructure and electric vehicles requiring substantial amounts of a range of metals, including copper and steel, this could bolster the financial performance of the mining sector, as well as the firms that work with them, over the coming years.

Although Weir has very limited exposure to the UK economy, with the company generating less than 1% of its sales domestically last year, an uncertain global economic outlook could weigh on its near-term performance.

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The firm’s balance sheet, though, suggests it has the financial strength to overcome elevated geopolitical risks. Its net debt-to-equity ratio, for example, amounted to 68% at the time of its half-year results, while operating profits covered net interest costs 9.9 times during the six-month period. Both figures also suggest the firm could make further acquisitions to boost its long-term financial outlook after making several purchases over recent years.

Trading on a price/earnings (PE) ratio of 23.6, the company’s shares are substantially more expensive than many other FTSE 100 index members where the average PE is 17.8. However, given the firm’s strong fundamentals, it appears to be worthy of a premium valuation and still offers good value for money. The company’s upbeat long-term financial outlook means that it could deliver further impressive capital growth, even after rising by 31% and outperforming the UK’s large-cap index by 12 percentage points, since the start of the year.

Relx

Fellow FTSE 100 member RELX (LSE:REL) could also deliver index-beating performance in the long run. The company, which provides data analysis tools to aid decision-making in a range of industries including insurance and retail, is benefitting from a continued shift in its business model.

It is moving away from print publishing and towards decision tools, which could offer better growth opportunities. Its latest quarterly trading update, meanwhile, stated that it expects a further improvement in operating profit margins after they rose by 70 basis points to 34.8% in the first half of the year.

The company’s shares have, of course, produced a disappointing return over recent months. They have fallen by 13% since the start of the year, versus a 19% rise for the FTSE 100 index, as investors have apparently become increasingly concerned about the potential impact of artificial intelligence (AI) on its core business.

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However, the firm has in fact been able to utilise AI to boost the performance and accuracy of its tools. Its solid financial position, as demonstrated by net interest cover of 7.1 in the first half of the current year, suggests it has the capacity to further invest in long-term growth and overcome a potentially uncertain period for the world economy in the short run. A sound balance sheet also means the firm can make further acquisitions after spending £262 million in the first six months of the year on three businesses.

Even after its share price fall, Relx trades on a lofty earnings multiple of 26.1. As with Weir, this is relatively expensive even at a time when the FTSE 100 index trades close to a record high. But with Relx set to benefit from an upbeat long-term global growth outlook, with 93% of its sales being generated abroad, and it having strong fundamentals, it appears to offer a favourable risk/reward opportunity at its current price level.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.