Invest as much of your annual ISA allowance as you like in either a Stocks & Shares ISA or a Cash ISA, or any mixture of the two
Some people never look beyond Cash Individual Savings Accounts (ISAs), but by using Stocks & Shares ISAs too, you could get a higher return on your investment. Stocks & Shares ISAs can contain shares, bonds and investment funds. There are no restrictions about where in the world you can invest: it does not have to be all in the UK.
ISA allowance
Following 1 July 2014, you can now invest as much of your annual ISA allowance as you like in either a Stocks & Shares ISA or a Cash ISA, or any mixture of the two, as long as you don’t exceed the annual limit. The annual
limit is currently £15,240 for the 2015/16 tax year.
Building up a reserve of ready money before heading into riskier assets like shares is good practice, and it has been recommended that people try and maintain three to six months’ worth of income saved as cash which can be used for emergencies.
Financial plan
At this point, having created a buffer, the next step is to decide on a financial plan, determining what your investment objectives are, your financial capability and, most importantly, how much risk you are willing to take.
Whatever your age, risk profile and wider portfolio, it is inadvisable to put all of your money in the same asset class. So don’t invest everything in the UK stock market or US government bonds. Diversification is one of the first principles of investing.
Did you know?
• You can decide how you want to split
the £15,240 between the Cash and Stocks & Shares parts of an ISA
• Or you can allocate the whole £15,240 into either a Cash or Stocks & Shares ISA
• Previously, you could only put up to half the annual ISA allowance into a Cash ISA
• You can move your money from a Stocks & Shares ISA into a Cash NISA, or vice versa
• Previously, you couldn’t move money from a Stocks & Shares ISA into a Cash ISA
• You pay no tax on the interest you earn in a Cash ISA
• With a Stocks & Shares ISA, you pay no capital gains tax on any profits and no tax on interest earned on bonds. The dividends paid on shares or funds do have the basic rate of 10% tax deducted. This means that higher- and additional-rate taxpayers don’t have to pay their higher rate of tax on their dividend payments
Lower-risk options
For those who prefer a lower-risk option, there are various options you can take besides simply leaving all your money in cash.
You could find a fund that invests in fixed-interest securities, known as ‘bonds’. These are less risky than shares but may perform better than cash, especially with today’s current low interest rates.
If you want to take as much risk off the table as possible while still using your entire ISA allowance, it may make sense to leave the maximum amount in cash and invest the other funds in government or corporate bonds.
Although bond funds are low risk, it is still worth noting that the value of your investment may go down as well as up, and you may get back less than you put in. That said, the best bond funds have an excellent record at preserving investors’ capital and have grown it significantly too.
Remain defensively positioned
If you are seeking a higher return on your investment but still want to remain defensively positioned, you could start looking at the stock market.
Accessing stocks and shares (or ‘equities’) through funds enables you to invest mainly in larger companies in developed markets, such as the UK, US and Western Europe, or a defensive global fund. ‘Income’ funds that invest in companies that pay dividends can be a good choice, because strong companies can maintain dividends even in bad times when their profits and share prices are falling.
Your main choice will be between actively managed and passively managed funds. Active funds are run by a fund manager who tries to beat the market by making better investing decisions than everyone else. Passive funds, which have lower fees and charges, try to match the performance of a well-established index, such as the FTSE 100.
If you go with an active fund, be sure to check the fund’s reputation and performance, but bear in mind this is not necessarily a guide to the future. With a passive fund, the important things are that it tracks its index accurately and has low fees.
Pound cost averaging
We’ve all heard that stock markets can be volatile and that the value of investments can go down. But there can be a positive side to these market conditions by regularly saving into funds through a Stocks & Shares ISA, a benefiting from a concept known as ‘pound cost averaging’.
Pound cost averaging is about regular saving. When investing, it’s always best to buy at the cheapest point – when prices hit the bottom. Yet predicting that point is extremely difficult. As a result, many investors miss it and act when the market starts rising.
However, you can even out the ups and downs when you make regular payments into a Stocks & Shares ISA investment, instead of paying in a one-off sum. By investing regularly – throughout the year, let’s say monthly – you spread the risk.
The money in your fund is used to buy units. If the unit price at that point is lower than the average price over a period of time, this can result in greater potential value. Remember though that, as with all forms of investing, nothing is guaranteed. You could gain less or lose more than if you had invested in one lump sum.
Potentially higher return
For those who are prepared to take more risk in order to get a potentially higher return, a move away from income-producing assets (such as bonds or the shares of big companies) towards capital growth may be worth considering. If you are willing to take an aggressive approach, it may be worth looking at small- to mid-cap companies and emerging market funds.
Bear in mind though that you may need to change your asset allocation over time. As retirement approaches, for instance, you might want to use your ISA as a source of additional income (remember, you do not have to pay tax on any income you take out of your ISA, but income from a pension is liable for tax). In your fifties and sixties, you may want to switch some of your investments from stocks and shares to bonds, for example.
Ultimately, while ISAs offer welcome tax-efficient incentives to savers, the rules of the market still apply. All the tax exemptions under the sun won’t return your cash if you make some awful investment decisions. After all, it’s just a wrapper – it’s what you put in it that counts.
