10 surefire steps to ISA success
1 Watch the compensation limit
The Financial Services Compensation Scheme limit for compensation for investments is £50,000 per FSA-authorised firm (and £85,000 for cash deposits.)
According to the FSCS, it will cover up to this amount if a firm is unable to pay claims brought by investors as a result of misleading advice or negligent management, or because the company has gone bust.
2 Choose your time horizon
While you're likely to get better returns from a stocks and shares ISA over the long term, there's little point investing if you'll need access to your cash within five years. As a rule of thumb, an investment in equities should be left for at least five years to reduce the impact of short-term market ups and downs and on its long-term growth trend, whereas many cash investments can be accessed as and when you need them.
Your needs are likely to change over time: younger investors with a longer time frame for their ISA can focus on capital growth for their investment; as they get older, they may decide to switch to an income stream.
If you have a cash ISA, or hold corporate bond or gilt funds within a stocks and shares ISA, then there is no income tax to pay. But any dividends paid by the underlying companies in an equity fund have a 10% withholding tax 'credit' deducted. This applies to both ISA and non-ISA funds, but it cannot be reclaimed by ISA investors. So it makes best tax sense to hold cash, corporate bonds or growth funds that don't invest in dividend-paying companies in your ISA, rather than equity income funds.
However, stocks and shares ISAs grow in value free of capital gains tax; if you're investing up to your ISA limit in the markets each year and holding your funds for the long term, this could amount to a significant tax saving and could be a far more important consideration than the loss of the dividend tax credit.
4 Use a fund supermarket
The advantages of going through a fund supermarket are on price, flexibility and choice. Using a supermarket, you can invest in a wide range of funds and keep them on a single platform. If you buy through a fund supermarket or an 'execution-only' broker, there is usually no initial charge on the funds. In addition, supermarkets offer the flexibility to switch holdings quickly and easily online.
However, if you want to invest in individual shares or investment trusts, you can set up a self-select Isa wrapper. There will be dealing charges to pay on these investments, and typically also a separate annual fee for the Isa wrapper, but Interactive Investor is one sharedealing website that offers the wrapper free.
5 Diversify your portfolio
To reduce risk, don't put all your eggs in one basket. Invest across a range of asset classes including cash, property, equities and bonds. By spreading your investments between different asset classes and geographical regions, you can help to reduce the risk involved. There is often little correlation between the performance of different asset classes; for instance bonds have historically done well when shares fall in value.
It's also useful to understand how different asset classes and geographical regions contrast. 'You may want to take, say, a cautious approach, but if your portfolio comprises only similarly structured cautious funds there is a risk that you have not really diversified at all, because much of the portfolio will be invested in the same areas and behave in the same way,' adds Peter Chadborn, IFA at Plan Money.
Be aware, too, of the individual stocks held by the funds you are invested in, and avoid too much duplication. For example, many investors had multiple exposure to BP shares through their fund portfolios – and were hard hit when the Deepwater Horizon oil spill occurred and the share price subsequently plummeted.
6 Be contrarian
Don't be swayed by short-term hype. Look for a fund manager producing consistently decent results – even though they are few and far between.
Don't necessarily write off a fund that has had a less successful year if the manager has performed reliably in the past. And conversely, think hard before you jump on the bandwagon of this year's most successful funds. How much further is there to go for the markets in which they're investing?
7 Advantages of regular investing
For a stocks and shares ISA, it is wise to set up regular payments to drip-feed your money in – that way, you take the difficult business of 'timing the market' out of the equation. Instead, you pay in through both rising and falling markets: your contribution will buy more units when stocks are cheap, and fewer when they are more expensive.
Graeme Mitchell from Lowland Financial adds: "That way you are not putting all your ISA money into the market at one time, yet you have the potential for much better longer-term returns only possible with stocks and shares." Additionally, the average cost of the units you buy is lower than the average cost of a single unit over that time – a benefit known as pound cost averaging.
9 Rebalance your portfolio
It's important to ensure that the structure of your portfolio remains in line with your overall risk profile as the investments grow.
"Over time, the more adventurous funds in your portfolio will perform better and therefore make up a greater proportion of the portfolio, relative to the more cautious funds," says Peter Chadborn. "This will gradually shift your profile up the risk scale, so while you may be happy with the performance, be aware that you may have adopted a risk profile with which you were not initially comfortable." If you remain more cautiously inclined, you'll need to reduce the size of the best-performing holdings and boost that of the slower-growing funds.
10 ISA as part of pension planning
Consider your ISA investment as part of your overall retirement planning. Pensions are a more tax-effective vehicle, with full tax relief on all contributions; you will pay tax on the income you eventually take, but you may well be in a lower tax bracket by then.
However, the cash can't be accessed until the age of 55. Most ISAs, on the other hand, can be accessed whenever you want, but also offer attractive tax benefits, as returns are free of tax. Fewer restrictions apply and they are generally simpler and more flexible than pensions. Income from ISA investments over the years could add a considerable tax-free sum to your total retirement income.
This article was written for our sister publication Money Observer
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Sometimes known as a trading ISA, a self-select ISA gives investors full control over which assets to include in their ISA, allowing them to choose individual shares and bonds rather than investment funds. Aimed mainly at experienced investors and subject to the same investment limits of a regular ISA, a self-select ISA will usually be managed by a stockbroker on an investor’s behalf.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Describes the relationship between a client and a stockbroker or independent financial adviser whereby the broker or adviser acts solely on the client’s instructions and doesn’t offer any advice on which shares to invest in or financial products to buy and simply “executes” the wishes of the client, regardless if they are judged to be sound or wrong. Other types of broking service offered are advisory (whereby the client/investor makes the final decisions, but the broker offers advice) and discretionary (whereby the broker manages the portfolio entirely and makes all the decisions on behalf of the client).
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.