When buying an ISA there are are two key factors that will likely determine how successful your investment is: What you buy and how you buy it.
What you buy is by far the more important. Invest in the wrong market at the wrong time and you’ll incur painful losses. Get it right and you’ll reap nice profits.
Of course, this is also the hardest decision to make. Unless you have a crystal ball you’ll never get it right all the time, which suggests that making smaller bets within a good spread of investments is more sensible that betting your shirt on a single investment.
Are the tax benefits worthwhile?
You can read a lot more about this, including examples, on our ISA page. But in summary:
- all taxpayers benefit from tax-free interest, e.g. income from corporate bonds.
- higher rate taxpayers benefit from having no further tax to pay on dividends, e.g. from equity income funds.
- everyone potentially benefits from tax-free gains, although careful use of annual capital gains tax allowances can achieve the same result for many investors.
- ISA income doesn't need to be declared on tax returns, hence it doesn't affect higher income tax age allowances.
Bottom line, if you're not paying for an ISA wrapper then it's better having than not.
When deciding what to buy I think there are five main issues to consider:
Look for gaps in your existing investments
In general it makes sense to invest across the main investment types: cash, fixed interest, stockmarkets, commercial property and commodities. And, where appropriate, to hold a mix of investments in each, e.g. global stockmarkets, not just the UK.
Rather than simply opt for whatever’s performed well in recent years, take some time to consider the best way to complement any investments you already own.
What do you want to achieve?
Ok, the obvious answer is to make money. But do you need an income? How long can you afford to tie up the money? And, if markets do fall, how much could you stomach losing?
Your answer to these questions will impact on the mix of investment types that is probably right for you. For example, fixed interest is more suited to income and usually less volatile than commodities. And while emerging stockmarkets hold more promise longer term than developed, there’s a greater risk of large losses along the way – I reckon it’s at least a 10 year bet.
Rather than cover all aspects here, I’ll point you to our investment pages that contain far more detail, including the pros and cons of each main investment type.
Funds or shares?
Once you’ve decided on where to invest, you’ll need to choose between using a fund(s) and buying directly, e.g. shares. In the case of commercial property you have little choice; you can’t buy an office block in an ISA, so you’ll need to use a fund. But you could buy individual gilts and corporate bonds for fixed interest exposure and shares for stockmarket and commodities exposure.
There’s no right or wrong answer here. If you’ve got the time to research investments then picking your own shares is likely to be cheaper than using a managed fund and you could outperform the professionals. On the downside, it’s unlikely you’ll be able to get as much diversity (most funds hold 50+ shares/investments) and you might fail miserably.
Active or passive?
If you opt for a fund you have a fundamental choice between an active fund manager, who’ll likely charge you between 1-2% a year, and a passive (i.e. tracker) fund, probably costing less than 0.5% a year.
Tracker funds tend to work well in some markets but are less successful in others – in practice you’ll probably want to hold a combination of both active and passive funds. Before deciding, I suggest reading our trackers page to find out more.
Choosing a fund
When choosing a tracker the main considerations are: the index being tracked (i.e. does it provide worthwhile exposure to the area where you want to invest), whether the fund accurately tracks the index and charges.
As for actively managed funds, they key question is whether the manager is likely to beat the index (else you might as well buy a tracker). Studying the manager’s credentials, including past form (look for consistency) and whether their management style (e.g. aggressive or cautious) suits the current outlook, can help. But ultimately you’ll be taking an (educated) leap of faith.
Once you’ve decided what to buy then seek out the best deal. If you opt for shares then consider a stockbroker with low dealing charges that doesn’t charge for an ISA wrapper. See my answer to this question for more details.
When investing in a fund decide whether or not you need advice. If you do, then seek help from an independent financial adviser (IFA). But if you’re happy making your own decision (perhaps with the help of useful research and guidance) then using a discount broker, who’ll refund some of the commissions normally paid to an adviser, can save you money. Read our ISA Discounts Action Plan to find out more.
Good luck,whatever you decide!