If you have five years or more to invest your money and are prepared to take some risk, then this type of investment Isa could be the right choice for you
Cash Isas have always been a favourite among savers looking for a place to build up a nest egg.
Savers shovelled as much as £39.8 billion into them in 2017-18 and they made up 72% of all Isas.
But while Cash Isas are a great place to protect money from tax and can, in some cases, shelter it from the effects of inflation, they are not a very effective place to grow your money.
Interest paid on Cash Isas rarely beats inflation these days, making it hard to grow your pot.
Increasing numbers of savers are turning to Stocks and Shares Isas instead in search of better returns.
While Cash Isas saw the biggest decline last year, with the number of subscriptions down by 697,000, Stocks and Shares Isas rose in popularity with 246,000 more accounts opened in the same period.
Are you ready?
A Stocks and Shares Isa can be one of the easiest and cheapest ways to invest.
Money held in Stocks and Shares Isas tends to go up in value over the long term but can experience volatility where the value rises and falls over the short to medium term.
This is one reason why it is best to invest only if you are planning for the long term – for at least five years.
It also makes sense to build up a cash buffer for life’s inevitable emergencies first, before locking up cash in investments. As a rule of thumb, it is wise to have three months of outgoings held in cash – just in case.
Once you have this in place, you could consider investing.
Why use an Isa?
There are several taxes associated with investing, but a Stocks and Shares Isa shelters your money from all of these.
Firstly, some investments pay interest, such as government and corporate bonds or rental income from some property funds. There is no tax to pay on this income if the investments are held in a Stocks and Shares Isa.
Secondly, any dividends paid by your investments are tax free if held in an Isa. The annual dividend allowance for investments not held in an Isa was slashed in the 2018/19 tax year to £2,000 from £5,000, so it is even easier now to be hit by the tax if you don’t use an Isa.
Thirdly, an Isa shields your investments from capital gains tax on your investment growth. Capital gains tax is payable on investments that have increased in value when you come to sell, on anything over £11,700.
Money saved in a Stocks and Shares Isa is protected by the Financial Services Compensation Scheme (FSCS) up to £50,000 in the event of an investment product provider going bust. However, it does not cover losses from the underlying stock market investments.
Is it very different to a Cash Isa?
Moving from building up a nest egg in a Cash Isa to putting money in a Stocks and Shares Isa can be quite a transition.
With a Cash Isa, you know exactly how much money you have and can expect to have at any one time.
The value of a Stocks and Shares Isa is never crystalised until you sell your investments. You can check its value at any time, but it can change from one day to the next.
Investors need to be able to reconcile themselves to the fact that their investments can fall in value, but that by the time they want to access them they hopefully will have risen overall.
How do you open one?
Opening a Stocks and Shares Isa is simple and has never been easier.
You will need to pick an investing platform and there are increasing numbers available, catering for anyone from those who want someone to pick their investments for them to those who would like full control.
Pick a platform that allows you the type of control you are after, that offers good customer service and that allows you to buy the range of investments you want.
You can use a Stocks and Shares Isa to buy bonds, company shares and funds, but investing platforms vary in what they offer.
For beginner investors, Moneywiserecommends using funds as these allow you to spread your risk across a greater number of holdings.
Many investing platforms have recommended lists of funds, which can be a good starting point.
Moneywise also has a list of First 50 Funds for Beginners, which we believe can form the basis of a good portfolio for first-time investors (see here for the updated list).
How much will I pay in fees?
One of the most crucial factors to consider is price. Each fund applies a charge to investors and you will also pay platform fees to the company you use to invest.
Costs can quickly erode your returns; an extra percentage point paid in fees can cost you tens of thousands over the long term.
Examples of major platforms include AJ Bell Youinvest, Charles Stanley Direct, Hargreaves Lansdown and interactive investor (Moneywise’s parent company). Each charges a fee, which is usually a fixed fee or a percentage of your Isa’s total value.
Are there other alternatives?
Lifetime Isas are another way of investing, of particular value to those saving towards their first home or retirement. Read this to see how they work.
Innovative Isas are the newest type of Isa and since 2016 have allowed investors to hold peer-to-peer (P2P) investments within an Isa.
These can offer considerably higher returns than Cash Isas, but they also come with greater risk.
Your cash is at risk if the platform goes bust and you are not protected by the FSCS as you would be with a Cash Isa.
P2P is also a relatively new product and has yet to be tested in a major financial downturn.
In a downturn, loans are more likely to default and returns fall. It remains to be seen how different P2P investments stand up against this type of environment.
Some platforms do have some safeguards and provisions in place to mitigate against this in part.