Inside an ISA wrapper, your money can grow without attracting any capital gains tax, which could otherwise reduce your profits by as much as 20 per cent.
In recent years, the amount of money you can invest using an ISA has grown hugely. In 2007, the annual ISA allowance was just £3,000. A decade on and you can put £20,000 into an ISA every year, all or part of which can be in an investment ISA – one that allows you to invest your money into stocks and shares, or other assets such as commercial property, commodities or bonds.
These details are, of course, subject to change and tax treatment depends upon your individual circumstances.
Choosing an Investment ISA
The first thing to remember is that this is an investment rather than savings. As such the value of your investments can go down as well as up and you might not get back the amount invested. So in general an investment ISA is not suitable if you are looking to put money away for a very short time.
1) Time frame
In the long term, research such as the Barclays Equity Gilt Study1, which looks at the historic performance of assets, show that stocks and shares have outperformed the safer option of cash holdings over most 10-year periods in history. If you are investing for five years or more, it may be worth considering investment ISAs as part of the mix, with the aim to help your money keep pace with inflation. Past performance, however should not be seen as a guide to future performance.
As well as considering your time frame, it is important to consider your risk tolerance. While investing money will always involve some risk, ensuring that you have a diverse portfolio of different types of assets such as shares, bond and commodities should help insulate you against market volatility as different types of asset tend to perform differently at different points in the economic cycle.
You could also consider a regular investment plan, where you put some money into your ISA every month. This means that you won’t be trying to pick the best time to invest your money, but will be drip-feeding money as the market moves up and down, which may give your investments a smoother ride. BMO’s Stocks and Shares ISA allows you to invest as little as £50 a month, so you have the opportunity for regular investments.
On the other hand, if you have a large lump sum to invest, leaving it in cash with the intention of gradually drip-feeding it into investments may mean, you miss out on gains and dividend payouts. As the old saying goes, “it’s time in the market, not timing the market that counts”, to ensure that your money gets as much of a chance to grow as possible.
When considering when to start investing, don’t forget the power of compounding, which means that over time the returns that you’ve made from your investments generate their own returns if you reinvest them – like a snowball rolling down the hill that keeps gathering more snow. This means that the earlier you start, the more impact your investment could have.
Types of investments
It’s easy to be bewildered by the different types of investment you can hold in an ISA. Although it is possible to hold shares in single companies, beginner investors may be daunted by the amount of research required to pick stocks and create a diverse portfolio.
It may be easier to invest using funds, which allow you to pool your money without investors to create a ready-made portfolio. There are different types of funds too.
Some investors choose a passive fund. These low-cost options are also often known as tracker funds, as they simply follow the performance of a market (such as the FTSE 100), and your portfolio will perform in exactly the same way as that market.
Active funds, which have a manager who chooses which stocks to buy or sell, aim to beat the performance of the market using management expertise. You’ll be able to see how successful they have been by using the fund’s “factsheet”, which has performance statistics and shows the main assets held by the fund itself.
Some ISAs allow you to invest in investment trusts, a type of fund traded on the stock exchange. Investment trusts are particularly well known for increasing their dividends – normally in the form of cash payouts to shareholders – year-on-year, which could be worth considering if the potential to receive regular income is important to you. BMO’s stocks and shares ISA provides the option of investing in 10 investment trusts covering equities, bonds and property.
Dividend payouts could be an important part of your total return on your investments. Not all companies pay them, but those that do usually distribute them quarterly, annually or biannually.
Some funds – known as income funds – concentrate on businesses that pay these dividends and pass them on to investors, while investment trusts, as mentioned above, pay their own dividends out. Some investment trusts have increased their dividends for 50 consecutive years, such as the F&C Investment Trust who have seen there 47th consecutive annual increase. Though there is no guarantee that this will continue to be the case of course.
As with all investments, the value of an investment in both funds and trusts can rise and fall and you may get back less money than you originally invested.
Ensuring that you have a properly diversified portfolio is really important, so if you’re not sure of the best assets to fund your retirement, an independent financial adviser could help.
This article written by Rosie Murray-West was first published on the Telegraph here.