One of these is a £20,000 annual allowance for a cash ISA, which operates in much the same way as a typical savings account. Another is a stocks and shares ISA, which allows you to invest in a range of different asset classes and instruments.
Returns from any investments or savings held within the product are not subject to income tax or capital gains tax (CGT). Through an ISA, you have every opportunity to build a nest egg for that dream holiday, second home, children's education or to support a decent standard of living in retirement.
According to HMRC, around half of all UK adults have an ISA and between these they have accumulated almost £500 billion of assets. A wide range of asset classes are available to you, including individual company shares from the UK and overseas, and government or corporate bonds.
Actively managed funds and exchange-traded funds (ETFs) are also a very popular and straightforward option as they can provide broad-brush exposure to an industry or geographic region for a relatively small outlay.
Shares offer both the potential for capital gain – if the share price goes up – and income from dividend payments. By reinvesting these dividends, investors can secure a substantial long-term return from the stock market.
If you put money into an investment that delivers a consistent return, and reinvest that cash as and when it is received, you capture the future returns on your reinvested profits as well as from your original investment.
The effect is even more powerful with dividends, because as you increase your holdings of a particular stock, you increase the amount of dividend income you receive. This happens as the level of payment is dependent on the number of shares you own.
Research by Shares Magazine indicates that from its inception in 1962 to 2010, the FTSE All Share generated a compound annual growth rate (CAGR) of 7.3 per cent, excluding dividends. If an investor had put £10,000 into the market at the beginning of that period they would in theory be sitting on a handsome return, with that position worth £314,067 in 2010.
However, if we include the 3.8 per cent long-term average dividend yield for the UK market, and assume this was reinvested each year, the value of the portfolio soars to £1,582,554.
Opening an ISA means choosing a product and provider which best suits your investment goals. It’s extremely important that you are able to trust your ISA provider, so to ensure you are dealing with a genuine firm and not a fraudulent outfit, you can find a list of approved providers here.
By going with an authorised firm you can enjoy the tax breaks associated with an ISA with confidence. You’ll also have the peace of mind of knowing that the Financial Services Compensation Scheme will cover you for up to £50,000 if the worst happens and your ISA provider goes out of business.
It’s also worth looking at the track record and financial backing of a prospective provider, and there’s no harm in asking friends or family if they have any experience of dealing with them in the past.
If you already have ISAs in place from previous years, you can choose to move them all to another provider. Your new provider will deal with the process of gathering the various funds into one account for you. A move like this will allow you to consolidate all your existing ISAs in one place.
Consolidation of various ISA holdings increases transparency and can make it easier to track how your investments are performing. If you’re building a portfolio of shares and funds across geographical and industry sectors, it will help to monitor your exposure, manage your asset allocation and spread the risk.
Once you have chosen a provider, setting up an account is a simple process. You will usually have the options of applying online, over the phone or by sending an application form through the post. The whole process can take as little as ten minutes.
You will usually be asked to provide:
|Type of product||What can you put in it?||Is your money protected?||What kind of return can you expect?|
|Cash ISA||Cash||Yes for up to £85,000 by the Financial Services Compensation Scheme (FCFS)||If you are prepared to tie up your cash, you could receive a return of around 2 per cent; if you want easy access to your cash, returns are more like 1.2 per cent|
|Stocks and Shares ISA||Shares, Funds, ETFs, Bonds and more||Not against investment loss but up to £50,000 by FSCS if your provider goes bust||Although past return are not a guide to future returns, historically UK shares have delivered a total return of around 10 per cent|
This article first appeared in the April 2018 issue of Investment Edge Magazine, a digital magazine packed with tips and advice for investors.
EQi does not provide investment advice. Investment Edge is provided by Shares Magazine and is the author’s view and is not the view or opinion of EQi and EQi accepts no liability for any loss caused as a result of the use of this information. The opinions expressed are those of the author at the time of writing and should not be interpreted as investment advice.