For those who want to grow their money efficiently over the long-term, a stocks and shares ISA is a great place to start. ISAs always get a lot of attention at the end of the tax year, but the savvy investor knows it’s the early bird that catches the worm.
Best described as a tax wrapper that protects your money from the taxman, you can put up-to £20,000 in your ISA and all of the interest, income and capital gains generated can grow in your ISA tax free until you want to take your money out.
This is the main draw of the ISA. It’s a simple and tax-efficient way to grow your wealth over time.
There are many different types of ISAs – including Lifetime ISAs, Junior ISAs, and Innovative Finance ISAs – although the two main ones are cash ISAs and stocks and shares ISAs.
You can decide whether to put your allowance in one particular ISA, or split it across a few, although you can only open and put money into one type of ISA each tax year.
Should you have a cash ISA or stocks and shares ISA?
Both cash ISAs and their stocks and shares cousins play an important role in financial planning.
If you have a short time horizon or prioritise protecting the value of your money, a cash ISA might best suit your investor profile and goals. Unfortunately, inflation can silently eat into the purchasing power of your cash savings over time.
Although interest rates are still historically low, even if they are on the rise again after well-over 100 months of being at rock bottom, inflation is well ahead of the Bank of England’s 2% target.
If you’ve saved up three months of outgoings, have paid off any expensive debt, and have a longer time horizon, you might want to make your money work harder for you on the financial markets.
Over the long-term, investing often outperforms cash. Take this research from Barclays, which showed that stocks and shares ISAs outperformed cash ISAs 91% of the time over ten years.
Time is your friend
It’s easy to agonise over the best investment strategy to help you reach your goals and there are many habits designed to help maximise your returns. The one thing you really need is time.
Encouraging you to ride out short-term fluctuations, a longer time horizon allows you to take on more risk with your money in the hope that you’ll get higher returns.
Risk and return work together, so the more you want your money to grow, the more risk you need to take with your investments. The markets rarely get to their end destination in one swoop, there’s often short-term volatility along the way.
But riding these fluctuations out could be all you need to see your money go further. A well-thumbed research paper from asset manager JP Morgan highlights just how damaging missing the ten best days of performance can be on your overall return.
If you’d have invested in the S&P 500 in the two decades to 2014, you’d have made nearly 10% a year on average. Take out the ten best days and this performance slips back to just over 6%.
This highlights just how much trying to time the market can be on your investments. Although short-term volatility can make investors sell-out of their investments, the best performance can often follows these days of poor trading, leaving some investors out of pocket.
End of the tax year
As the City clears up from the celebration of the tax year-end and the ISA season winds down, investors fall victim to ‘out of sight, out of mind’, which could be diminishing the potential for returns.
Many will wait until the last minute to decide how to make the most of their annual tax wrapper, but investors could increase their scope for returns with just a little bit of forward planning.
Here are four reasons why you should get ahead of the game and start maximising your ISA allowance today.
1. Maximise tax efficiencies
The main benefit of an ISA is that your investments can grow tax free. You won’t pay capital gains tax if your investments increase in value, and your income is also safe from the taxman – whether from dividends or bonds.
If you start investing earlier in the year, you stand to benefit from the tax-free returns for longer. However, as the annual CGT allowance is £11,300 for 2017/18, this won’t necessarily affect all investors.
2. Maximise returns
The case for long-term investing is well established, and whilst a year is usually considered short-term, it’s a lot longer than just one month. This will give your investments more chance to grow, although the value of your portfolio can go up or down.
A diversified investment strategy looks to smooth out sector-specific risks by offsetting any negative performance with the positive. The earlier you start, the more opportunity your investments have to grow tax-free.
3. Get peace of mind
You either use the annual ISA allowance, or you lose it. Taking advantage of your tax-free wrapper earlier on in the year means you don’t have to worry about missing the deadline next April.
Investing £20,000 as a lump sum isn’t possible for everyone. But if you plan ahead and contribute to your ISA on a monthly basis, you could end the tax year with a strong investment portfolio that’s grown throughout the year.
As timing the market is one of the hardest challenges facing investors, making regular deposits can take the emotion out of investing and provide the chance of smoother returns amid market volatility.
4. Hassle-free investing
Make your life simple. After signing your initial ISA declaration, you don’t have to fill in a tax return for your investments within your stocks and shares ISA. At Moneyfarm, we do the hard work for you – matching you to an investor profile and portfolio that’s specifically built to reflect your tolerance for risk. This allows you to focus on the important things in life.