It is safe to say that it has been a bumpy start to 2022. With inflation rising in the UK reaching the highest levels in 40 years and the Ukraine Crisis continuing on, it has become increasingly difficult for investors to navigate the markets.
How should I use my ISA allowance?
As a wealth manager, we speak to our clients on a daily basis and a number of key themes and questions have arisen over the last six months. Perhaps the most common topic is what to do with your ISA allowance for this tax year. Almost all asset classes are negative so far in 2022, but holding cash at less than 1% when inflation sits at 9% isn’t particularly appealing.
So, what should you be doing with your money? The important thing here is to focus on the basics. The most important factor in your financial planning is, as always, time frame. This is the key differentiator when we build our portfolios – the longer you have to invest, the more risk we put into the portfolios (as you have time to ride out volatility).
This is no different today. If you need to access your savings in the near future, then a Cash ISA might be the way to go – volatility is likely to continue over the next 6 to 12 months and it’s difficult to say whether markets will be up or down. Equally, the impact of inflation will be less dramatic over a shorter period.
If, however, your time horizon is broad (i.e you don’t need to access the money for some time), then you should stick to your original plan and invest with the entire time frame in mind, rather than focusing too keenly on the current disruption. Volatility is likely to continue in the short run, but this is part of a wider market cycle and, generally speaking, the recovery periods that follow sell-offs are some of the most lucrative in the markets. Markets are forward-looking and valuations have come down a long way – with a long enough time frame, you’ll be able to capitalise when the tide turns.
Cash is safe in the short term. However, over any kind of extended period it is guaranteed to lose value in a situation of high inflation like the one we’re currently in. If your interest rate is 0.5% and inflation hits 9%, you’ll lose 8% in the first year. If the second year has an inflation rate of 5%, this jumps to 13.5% by the end of it. Unlike markets, this is not a cyclical calculation; this is only going in one direction until inflation falls significantly below savings rates. This is a very rare occurrence.
What happens if markets continue to fall?
Another concern investors have is the possibility of contributing, only for markets to fall significantly straight away. As we said, this is an uncertain period and there’s no guarantee you’ll avoid short-term fluctuations. We do, however, believe that a lot of the bad news is already priced in, but there will be more action in the near future as optimism grows and fades.
So, naturally, this creates uncertainty for investors. There are two key points here. The first is that, if you get started now, you’ll have the best part of 9 or 10 months until the ISA allowance deadline. This means you can break out the allowance over time and drip feed cash into your portfolio. Staggering your entry point into the markets can help manage short-term risk – some months you’ll buy before a dip, others you’ll buy before a period of growth.
Secondly, if your time horizon is long enough, short-term volatility doesn’t actually matter all that much. This might sound strange but the data shows it to be true – it’s essentially impossible to time the absolute bottom of the market. The old adage rings true here: “Time in the market is more effective than timing the market.”
Ultimately, it’s a matter of preference. If you’re investing for the long term, it can make sense to invest when the markets are going badly, so you can take advantage of any recovery that might be forthcoming. Alternatively, you could drip feed your ISA allowance into the markets over the next 9 months to smooth out the ups and downs.
Where should I use my ISA allowance?
So, where should you put your ISA allowance this tax year? With inflation and interest rates as they are, it’s clear that there’s risk associated with cash investing – you’re starting the year at a negative real rate of return before you’ve even started.
Although cash is typically seen to be a lower-risk asset when compared to the likes of Fixed Income or Equities, this risk is particularly pertinent for medium to long-term investors due to high levels of inflation; just like positive interest rates, this negative real rate of return can compound over time.
Stocks and Shares ISAs typically offer an uncapped percentage return and are dependent on the markets themselves. This can be great when markets are performing well, however, can also increase risk when markets are performing badly.
In times of uncertainty, Stocks and Shares ISAs can increase in risk. This is because assets like Equities and even Fixed Income are more affected by volatility than cash. This risk increases dramatically for people invested in a Stocks and Shares ISA over the short term, as there is a chance you could lose a percentage of your invested capital and not have the time to ride out a recovery.
However, as we’ve said, as your time horizon increases, the impact of volatility starts to decrease. Therefore, some longer term investors may see this recorrection as a buying opportunity. This is because investors are able to purchase units within a portfolio at a discounted price, allowing them to get more for their money and increase gains over time. To put this into perspective, it would be like walking into a shop with £100 when it has a 50% sale on. Your £100 can now buy you double the amount it would have been able to before.
Key things to consider
In conclusion, there is no one ISA which is superior to the other. Each holds their own benefits and appeals to different types of investors. However, it is clear that your investment time horizon should play a key role in deciding which ISA works best for you. Along with the inflation rate and real rates of interest.
Ultimately, if you’re unsure and want to discuss your options with someone, we suggest that you talk to our consultants. You can book a call with your dedicated account manager here, and they’ll help you talk through your financial plan and your options regarding your ISA allowance. To book a call, reach out to us on +44 20 3745 6991 or email us at hello@moneyfarm.com.
