Are you thinking of investing in an ISA before the end of the tax year on 5 April? With interest rates on cash ISAs still failing to keep up with inflation, a stocks and shares ISA might seem an appealing option if you’re saving for the long term.
But before you can work out whether or not you should invest in one, you have to understand exactly how they work.
The basics of stocks and shares ISAs
The starting point with investment individual savings accounts (ISAs), also known as stocks and shares ISAs, is that they generally invest in company shares, although they can also invest in other assets, such as property, bonds and cash. That might sound obvious, but it’s something that isn’t always made clear.
Although we talk about ISAs, the ISA part is actually a tax-efficient wrapper and it really is as simple as it sounds. Whatever you decide to invest in, whether that’s share-based funds, shares or bonds, you can place them in an ISA wrapper (just like wrapping a parcel) to ensure that you don’t have to pay extra tax on any profits when you cash your ISA in. Technically, ISAs aren’t tax-free because some tax has already been paid by the fund, but you don’t have to pay tax on any income or capital growth (the increase in the value of your investments), which makes them a very tax-efficient way to save.
Although the ISA tax break is useful, it’s vital that you understand what your money is invested in. There’s a huge range of stocks and shares ISAs on offer, which can invest in high risk share-based funds, such as those that buy shares in emerging markets, to lower risk funds which invest predominantly in bonds and gilts. You can find out more about the various different investment options and asset types below.
Choosing where to invest
If you don’t feel comfortable doing your own research and working out what you want to invest in, go and see an independent financial advisor.
You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guide on How to find the right financial advisor for you.
You can learn more about whether investing is right for you in our article Investing – the basics. Whether or not you take advice, it’s a good idea to have done some of your own research so you have an idea of what’s on offer.
If you’re looking to invest in an ISA, fund platforms such as Fidelity, Hargreaves Lansdown and AJ Bell can help narrow down your choices with recommended fund lists, which might highlight 50 funds out of the 3,000 plus available to UK savers. They also offer ready-made funds for a range of different risk profiles if you don’t want to pick investments yourself. Bear in mind that there are charges associated with stocks and shares ISAs and you’ll pay a fee to the platform as well as for the funds held.
Shares
Most people who take out a stocks and shares ISA put their money into one that invests most or all of their money in shares – typically through funds where you can pool your money with that of many thousands of other investors. Don’t assume that one share-based fund is similar to another. Stocks and shares ISAs have a nasty habit of looking similar on the surface but being very different when you get down to the fine print.
In his autumn statement, the Chancellor confirmed that ISA holders will be able to invest in fractional shares with a stocks and shares ISA. This essentially means that you own a portion of a share alongside other investors, rather than a full share on your own, meaning you can specify how much you want to invest in a particular company, instead of having to pay the cost of a full share.
Bonds
There are two different types of bonds that stocks and shares ISAs can invest in: corporate bonds (which are basically IOUs for money you’ve loaned to a company) and government bonds (which are otherwise known as gilts).
Many financial advisors recommend bond funds if you’re approaching retirement because they say these funds are less risky than investing directly in a single bond. The disadvantage is that you pay management charges to a fund manager who decides which bonds to buy and sell. Some experts argue that there can be hidden risks precisely because the fund manager buys and sells bonds, when the risk of holding a bond is at its lowest if you keep hold of it until it’s matured.
Property
There are many different types of property funds and trusts that invest in and sometimes buy commercial property, and can be held in an ISA.
A Real-Estate Investment Trust (REIT) invests in property directly. They will own a building or at least have a stake in the building. Often the REIT will have developed the property in the first place. Alternatively there are exchange-traded funds (ETFs) which track indexes with exposure to all the big UK property firms.
Cash
If you’ve decided to open a stocks and shares ISA but aren’t certain where to invest your money yet, you can usually keep your money in cash until you’ve worked out where to put it.
Multi-asset funds
If you want exposure to lots of different assets, another option is to invest some or all of your stocks and shares ISA allowance in a multi-asset fund.
This is a specialised fund, run by a manager, that is highly diversified between different types of investment. The aim is that investors end up with a balanced portfolio without having to make the individual asset choices themselves.
By spreading your money across a range of categories, you should reduce the risk of being unduly affected if one underperforms, as hopefully others may perform better, helping to offset any losses.
Can I get my money out of my stocks and shares ISA whenever I want?
You can usually take money out of your stocks and shares ISA at any time, but it’s worth remembering that investing is for the long term, so ideally you should aim to leave your money untouched for at least five years, but preferably much longer.
This is because markets can be volatile, and if you’re going to need your money in just a couple of years, there’s a high chance you could end up losing money if markets have dipped and the value of your shares, bonds, or funds has gone down. The longer you can afford to leave your money invested, the greater the chance it will have growing in value.
How much can I invest into a stocks and shares ISA?
The maximum you can invest in a stocks and shares ISA in the 2023/24 tax year is £20,000. You get a new Isa allowance at the beginning of each new tax year starting on April 6.
Some ISAs allow you to withdraw cash and then replace it within the same tax year, without this affecting your tax-free allowance. For example, if you pay in £20,000 and withdraw £5,000, you may be able to replace the £5,000 as long as you do so in the same tax year as you made the withdrawal. Not all ISA providers offer this flexibility so always check first that your provider will allow you to do this if you want to take money out.
You don’t have to invest your whole allowance into a stocks and shares ISA if you don’t want to. You can split it between other types of ISA, such as an innovative finance ISA or a cash ISA, so you might, for example, decide to put £10,000 into a stocks and shares ISA and another £10,000 into a cash ISA. Currently, you can only pay into one of each type of ISA in a single tax year, but the Chancellor confirmed in his Autumn Statement that you will be able to open and pay into multiple ISAs of the same type in a single tax year from April 2024.
If you go for the option of saving some of your ISA allowance in a cash ISA and putting the rest in a stocks and shares ISA, you don’t have to open up your ISAs with the same provider. You can take out your cash ISA with a bank or building society, for example, and open your stocks and shares ISA with an investment management company.
Can I transfer money held in a cash or innovative finance ISA into a stocks and shares ISA?
You can transfer money from a different type of ISA to a stocks and shares ISA and it won’t affect your annual allowance. However, you must transfer it directly from one ISA provider to another; you mustn’t cash in your ISA and put the money into an ordinary bank or savings account before it’s moved to your new ISA provider. If you do, you may have to pay tax on the interest you’ve earned. Be aware too that not all ISA providers accept transfers.
If you’re transferring money in a cash ISA from previous tax years, you can transfer all of it (plus the interest) or just part of it, but if your ISA has money from the current tax year only, you have to transfer the lot. Find out more in our guide ISA transfers: what are the rules?
Be cautious about moving big sums from cash to stocks and shares all in one go, unless you have a very strong appetite for risk. For example, how bad would you feel if you suddenly saw a 5% dip in the value of your holdings the day following an investment, or a 10% fall over the month following an investment? Instead you might want to consider drip-feeding the money into stock markets over a few months to help smooth out any potential volatility.