Stocks and shares ISAs are a tax-efficient way to invest, with returns free from income tax and capital gains tax. But should you take the plunge or stick with cash?
It’s a new tax year, meaning that your financial allowances, such as your ISA (individual savings account) allowance, will have all been refreshed.
Not surprisingly, plenty of us leave decisions such as whether or not to invest in an ISA until the last minute. But if you haven’t already decided whether to invest in a stocks and shares ISA, what should you consider?
The basics of stocks and shares ISAs
Stocks and shares ISAs can invest in a wide variety of investments. The ISA part is essentially a tax-efficient ‘wrapper’ which means you don’t have to pay extra tax when you cash in your ISA. What you invest in is up to you.
There’s a limit on how much you can invest in a stocks and shares ISA each year. This tax year (2023/24), you can invest up to £20,000, minus anything you decide to put into a cash ISA or innovative finance ISA. Here are some of the things you need to think about when deciding whether to put your money into a stocks and shares ISA.
1) What is your investment timeframe?
Do you need easy access to the money you’re thinking of investing in a stocks and shares ISA? You need to think whether you can really afford to tie it up for five years or longer or whether you will need access to it in the short term. If you think you’re going to need your cash in the next couple of years, you should probably look at a cash ISA instead.
Investing is only suitable for those who can afford to leave their money untouched for the long-term, as this will give your investments the best chance of riding out any stock market volatility.
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.
2) Are you comfortable with the possibility that the value will fluctuate?
As soon as you put your money into a stocks and shares ISA, the value of the investments you’ve chosen can drop as well as rise (and may fall dramatically). You need to be comfortable accepting the fact that the fund’s value can go down as well as up.
It’s often hard to imagine how you’d feel if you were to lose money. But try and think about how much risk you take in other areas of your life. You won’t necessarily feel the same about investment risk, but it could provide some clues. Otherwise, imagine you had £10,000 that you’d invested and it was worth £9,000, £8,000 or £7,000 a year later. How would you feel? Read our article What’s your attitude to risk? to find out more.
3) Do you know which funds to select?
There is a vast range of funds to choose from. If you’re not confident in selecting the ‘right’ type of funds for you, you should take advice from an independent financial adviser (IFA). If you want to do some of your own research, there are many online portfolio and fund selection tools to help you.
Don’t just choose any old fund. If you don’t know where to start, consider going for a multi-asset approach (which invests in things like shares, bonds, possibly commodities and so on). This should reduce your risk, but do check the charges and get to grips with what the funds invest in.
The golden rule is never to invest in something you don’t understand. From time to time, certain areas of the world or certain themes become fashionable to invest in and these are heavily marketed. These fashions will come and go so look beyond this and think about which themes make sense to you. If you can’t understand what’s involved, leave well alone!
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.
4) Understanding the importance of diversification
Diversifying just means spreading your money over several different geographical areas and types of asset. This will reduce your exposure if the one of the investments you have picked runs into difficulties and means you won’t have all your eggs in one basket.
Having a well-balanced portfolio can help smooth out your investment journey. But you’ll still need to be realistic about the returns you are aiming for, and you shouldn’t expect gains every year.
5) Can you stay calm when markets are volatile?
There’s no escaping the fact that investing in a stocks and shares ISA can be something of a rollercoaster ride, so you’ll need to accept that there are times you might be sitting on heavy losses.
However, even if your ISA falls in value, remember that you will only lose money if you sell. If you can afford to sit out short-term fluctuations you will (hopefully) see an upward trend over the longer term, although there are no guarantees. Find out more about managing market volatility in our guide Four ways to weather stock market storms.