Isas are better than ever, and more important than ever. Whether you are just starting out with investing or looking to top up existing savings and investments, they are the simplest and most competitive vehicle.
When Individual Savings Accounts (isas) were announced in 1998 pensions were still the main savings vehicle for many — especially the professional middle classes. Today, defined-benefit pensions have been eviscerated. There are few active schemes left outside the public sector, and steep reductions in the annual and lifetime allowances mean that better-off savers need to be careful about amassing large defined-contribution funds.
As trust in pensions has been eroded, Isas have got better. Most obviously, the annual allowance has risen dramatically in recent years. When they launched in 1999, the contribution limit for a stocks and shares Isa was £7,000. If that annual limit had simply risen in line with consumer price inflation, it would stand at around £11,200 today. But on April 6, the actual Isa limit rises to £20,000.
Isas used to be for over 18s only. Now you can set up a junior Isa for a child (the allowance is £4,128 for 2017-18). Not only does this introduce young ‘uns to saving, it also means you can use more of your own allowance for yourself. The Lifetime Isa, which launches in April for those aged 18-39, is a good way for young adults to save for a house deposit.
Shares in Aim-traded companies and corporate bonds with short maturities used to be off limits. Now either can go into an Isa. So too can alternative investment products like peer-to-peer lending, thanks to the Innovative Finance Isa. The tax benefits of Isas used to die when you did. Not any more: you can pass on your Isa savings to your spouse or civil partner.
The only thing that has not changed is the simplicity. Once inside the Isa wrapper, capital gains and income from your investments are largely tax free. That is especially valuable for stocks and shares, where the reinvestment of dividends can form such a large part of total returns. And this year, there is an extra reason to use your stocks and shares Isa allowance. Inflation is currently running at 1.8 per cent. The best instant-access savings account offers 1.1 per cent and the best one-year fixed-rate bond about 1.6 per cent. The prize rate on Premium Bonds has just been cut again. So by this time next year, any money you put in a savings account is guaranteed to have less purchasing power than it does now.
But what investments should you consider putting in a stocks and shares Isa?
Index trackers or exchange traded funds
These are simple products that just track the value of an index, minus a small charge to cover running costs. ETFs offer live pricing during the trading day, but you will usually pay a trading commission to buy or sell them. Index funds price once a day but generally attract no buying or selling charges (making them more suited to regular saving). Both are available for a wide variety of stock and bond indices, often at very low cost. All you have to decide is what mix of assets you want. The downside is that you will never beat the market — but then again, many fund managers do not manage that either. Legal & General offers a good range of index funds at low costs. For ETFs, iShares, dB x-trackers and HSBC are the three market leaders in the UK. Vanguard does both. Watch out for trackers offered by high-street brands such as Virgin Money and Marks and Spencer, both of which charge much more than the average.
These make things even simpler. They contain shares and bonds — usually held in the form of ETFs or index trackers — in different proportions. All you have to do is choose how much risk you want to take and pick a product accordingly.
Broadly, lower-risk options will contain more bonds and higher-risk ones more shares. Vanguard’s LifeStrategy range is the best known, but the BlackRock Consensus, Standard Life MyFolio and L&G Multi-Index ranges follow similar principles. Charges are slightly higher than for plain-vanilla index trackers or ETFs.
Actively managed funds
When people talk about “funds”, this is what they usually mean — it is a catch-all term for what Britons call unit trusts and open-ended investment companies (Oeics) and Americans call mutual funds. There is a bewildering selection of funds covering various regions, asset types and sectors, while multi-asset funds combine different asset classes in various proportions, like life strategy funds.
As the name suggests, a manager is paid to pick investments that he or she believes will outperform over the long term. This service comes at a price — charges on active funds are typically 0.5 per cent a year and upwards, considerably more than many passive products. Many also have relatively poor track records, often struggling to beat the index against which their performance is benchmarked.
But back the right manager and you can enjoy incredible returns, even after costs. Funds are usually free to buy and sell — you pay only the running costs and the investment platform’s charges — and most platforms allow regular investments at no extra charge, making them flexible. Most also have lists of the funds they consider the best performers; examples include Hargreaves Lansdown’s Wealth 150, Fidelity’s Select 50 and the Share Centre’s Platinum 120. Bestinvest and Chelsea Financial Services produce regular surveys naming the “dog funds” to avoid. Or you can do your own research at websites like Trustnet or Morningstar.
These are structured like a company; the difference is that instead of vehicles and factories, their assets comprise shares in other companies. The pool of investment capital is fixed at the start. Investors buy shares in the trust, rather than adding to the underlying investments. That makes investment trusts particular suitable for sectors where liquidity is limited or volatility high.
Examples include property, where buying and selling buildings is time consuming and costly; small-cap shares, where it can be difficult for a fund manager to buy or sell large volumes of shares without moving the price of them significantly; and infrastructure investments, which are typically held for long periods. Like companies, trusts can borrow to invest, boosting the profits made (though any losses will also be amplified). A variation on the theme is real estate investment trusts or Reits — companies such as British Land, Hammerson and Land Securities. These own and rent out commercial property and pay no corporation tax provided that they pass 90 per cent of their trading profit on to investors as dividends. Because investment trusts are quoted securities, you will have to pay commission when you buy and sell their shares.
Regular income funds
Income drawn from a pension is taxed, but anything you draw out of your Isa is not (because you have already paid tax on the money you put in it). The chances are you will need quite a large amount to generate a decent monthly income, but for those in this fortunate position there are funds available that distribute quarterly or even monthly, such as Premier Monthly Income or Threadneedle UK Monthly Income.
Traditional ways to own the yellow metal are expensive. Small bars or coins such as Britannias or Krugerrands incur big bid-offer spreads. If you are wary of keeping them at home, there are also storage costs to consider. But you can own gold through an exchange-traded commodity at relatively low cost. Be careful to pick one that is eligible for Isa inclusion — look for “Ucits-compliant” products such as the iShares Physical Gold ETC or Gold Bullion Securities.
If you are attracted to the recent returns of residential property but balk at the time and effort involved in being a buy-to-let landlord, there are several products that allow you to get bricks and mortar exposure via your Isa. The TM Hearthstone UK Residential Property fund owns 180 properties, mostly in the south-east of England. Castle Trust offers “Fortress Bonds”, an income product based on residential property loans. Landbay offers peer-to-peer lending secured against buy-to-let properties as an Innovative Finance Isa. The last two are loan investments, and are not covered by the Financial Services Compensation Scheme.
Jonathan Eley is deputy head of Lex