When Individual Savings Accounts (ISA) were first introduced in the UK in 1999, they accomplished two things. First, they replaced outdated savings vehicles that were not as attractive to UK residents. Second, they opened the door to savings and investment among people who believed they could never really afford to do so.
Today, consumers have a choice of saving through a cash ISA or a stocks and shares ISA. The stocks and shares option offers the opportunity to earn a higher rate of return despite the fact that it comes with a greater measure of risk. If you are thinking of opening an ISA, you should certainly investigate the stocks and shares option.
The idea behind the ISA when it was first introduced was to give UK consumers the opportunity to put some money away and invest within a more friendly environment. To accomplish this, the ISA was set up so that consumers would contribute to it using after-tax income. Once the money is invested in the ISA, it is no longer subject to taxes. The returns earned on the ISA are also not subject to capital gains tax.
Though this article focuses mainly on stocks and shares ISA's it is important to define both types of accounts for clarification. In the simplest terms possible, the two types of ISA's are:
- Cash ISA - The cash ISA is just an enhanced savings account that allows consumers to earn a return not subject to capital gains. It is the more popular of the two accounts because it offers stability and fairly low risk. On the downside, the interest rate is not as attractive as the potential earnings from a stocks and shares ISA.
- Stocks and Shares ISA - This ISA is designed to be both a savings and investment vehicle. When you use this type of account, you are able to put your money in several different types of investments including government bonds, corporate bonds, share funds, and individual shares.
There are other types of specialised ISA's that fall under one of the two main categories. An example would be a junior ISA for child under the age of 18. This type of account is used not only to save money for a child, but also to teach the child the basic concepts of financial management.
Stocks and Shares Risks
One of the fundamental rules of financial investing is that the potential for greater reward also comes with greater risk. That is certainly true of the stocks and shares ISA. When you invest in a stocks and shares ISA, it must be with the knowledge that your investment could lose money just as well as they could gain. You need to be willing to take that risk if you want the reward of a stocks and shares ISA.
To mitigate the risks as much as possible, financial experts recommend stocks and shares investors diversify their investments rather than put all of them into one or two vehicles. The reasoning behind this is the fact that it is not likely all of your investments will fail at the same time. If one were to fail, the rest should remain either stable or profitable.
The other risk with these types of ISA's comes by way of the term. In other words, although the ISA is not a replacement for a pension, plenty of older consumers use them as a pension supplement. If you are only a few years out from retirement, a cash and shares ISA might be risky because the term is so short. These types of accounts are better suited to long-term investors able to ride out fluctuating market conditions.
With that said, independent financial services company Hargreaves Lansdown reminds consumers that they can invest as much as £11,280 for the 2013 calendar year. That means an older couple could invest twice that amount, or £22,560. That could be the basis of a very nice supplement to a pension five or 10 years from now. Placed in the right financial vehicles, a stocks and shares ISA with this much money could be very attractive.
Investing in a Stocks and Shares ISA
If you want to enjoy the maximum benefits of a stocks and shares ISA, it is important to know how to invest. As we mentioned earlier, diversifying your investments is always a good idea. You want to build a portfolio that gives you a good mix of risk and return. If you only invest in low risk options, your return may not be worth your effort. On the other hand, if you invest only in high risk options you increase the chances of losing it all.
According to Which? there are four different types of investments to consider with a stocks and shares ISA:
- cash (buying and selling various currencies)
- commercial real estate
- corporate and government bonds
If you are not sure what these investments are, it's a good bet you are going to need some sound financial advice in setting up your stocks and shares ISA. This is okay. Most of us are not financial experts prepared to make these decisions on our own. Seek out the advice of a qualified financial investor with a track record of success.
As a rule, your financial advisor will help you diversify your investments according to your goals. If you're fairly young, he or she might recommend a portfolio that leans slightly toward lower risk options with the goal of building your savings over time. If you are older, he or she might recommend more risky investments for a greater return in the short term.
Investing in Share Funds
While we will not go to the details of every investment vehicle here, we do want to mention share funds due to the fact that they are among the most popular investment options. In some circles, the share fund is also known as the "open ended fund." The same product in the United States is known as "mutual fund."
A share fund is based on the idea that investing the collective funds of multiple investors in government and corporate bonds, or single shares, provides the financial strength necessary to maximize returns. A company offering a share fund has but one goal: to make money for all of the investors involved. However, when you invest in a share fund you are depending on the administrators of that fund to invest wisely on your behalf.
Share funds are attractive for two reasons. First of all, they offer relative stability because the collective funds of all investors are thoroughly diversified. The share fund is a good way to get a decent return at relatively low risk. The second thing that makes them attractive is that it takes the guesswork out of investing for the average consumer.
When you invest in share funds, you need to investigate and compare funds one against another. Some have very good track records of consistent profits while others might be a bit shaky. You certainly don't want to invest in a share fund with a losing record.
Investors who are confident enough to handle their own investments without the direct supervision of a financial advisor often find great success using a discount program and fund supermarket. The fund supermarket is like a clearinghouse of sorts where discount brokers can "shop" for the best funds for specific customers' needs and goals.
What can be purchased through the supermarkets depends on how your discount broker does business. Many of them include both open-ended funds and the various types of investment vehicles offered on stock exchanges. On the other hand, some discount brokers only work with open-ended funds.
Be aware that your discount broker earns his or her living based on commissions paid by both parties in the transaction. That's why some brokers concentrate only on open-ended funds, where they can work out very attractive commission deals with fund managers. In return, the fund managers get a bigger slice of the investment part because individual investors are not looking elsewhere.
Keeping up with Stocks and Shares Changes
Before we wrap all this up, we want to remind you to pay attention to the stocks and shares ISA environment in order to keep up with changes. In other words, as the years progress, the amount of money you are able to invest in your ISA will change. There are also regulatory changes that may affect your stocks and shares ISA in any given year.
If you are working with a financial advisor, it will be his or her responsibility to keep you abreast of what's going on. If you are investing on your own, or even with the help of a discount broker, keeping up with the changes will be your responsibility. Fortunately, there are plenty of websites offering good information of which you can take advantage.
Stocks and shares ISA offer a great opportunity to put some money away for the future while earning a better return than you get from the cash ISA. If you are looking for a way to help your savings grow at a faster rate, this might be a good choice for you. As always, invest wisely. Understand that any money you put into a stocks and shares ISA could be lost if your investments do poorly.
The number of options available to stocks and shares ISA investors is almost unlimited. To give you an idea of what is out there, we have looked at some reputable websites from companies offering these types of accounts. When you follow these links, you'll get a better picture of what your choices are.
Barclays - If you are like most people, you are already familiar with the Barclays name. On this page you can compare the different stocks and shares ISA's offered by Barclays, as well as several other investment options.
Halifax - This is the main entry point for investing in a Halifax stocks and shares ISA. The company thoroughly explains how their ISA's work in light of current regulations. If you want to apply online, the option is available.
Legal and General - Legal and General is a financial services and investment company originally established in 1836. This page gets you started in your search for a stocks and shares ISA with them. You can apply online if you decide this company is right for you.
Saga - Saga offers stocks and shares ISA's with no annual fees. When you visit this website, you will have access to all the information necessary to make an informed decision about Saga ISA products.
The Co-Operative Bank - The Co-operative offers stocks and shares ISA through a partnership with AXA. When you visit this page, you'll find plenty of helpful information including and easy-to-understand explanation of how their ISA's work. Current account holders can also log on and manage their accounts from here.
Aviva - Aviva has long been one of the strongest names in UK financial services. This link takes you to their main ISA page where you will find all the information you need about stocks and shares ISA's. They offer in online tool to help you determine the direction of your self-funded ISA. You can apply online should you decide to do so.
You can quickly and easily compare rates among stocks and shares ISA by using a comparison website. These sites collaborate with various service providers to offer Internet users better deals than they can get when shopping alone. The following links will take you to comparison websites where you can find stocks and shares ISA rates:
Go Compare - Compares stocks and shares ISA's from reputable companies. Their comparison includes a list of fees, minimum investment requirements, and other important information on a per company basis.
Money Supermarket - This site allows you to compare stocks and shares ISA's in two ways. First, you can compare among preselected fund ISA's from the website partners. The second option is to compare self-selected ISA's.
Confused.com - Here you have access to multiple stocks and shares ISA's thanks to this site's partnership with TQ Invest. Comparisons are offered side-by-side in an easy-to-read chart.
Money.co.uk - Dozens of stocks and shares ISA options are compared on this site side-by-side. The comparisons take into account protection schemes, minimum investment requirements, exit fees, and the number of funds available through a given ISA.
Love Money - Although this is more than just a comparison website, they do allow you to compare multiple stocks and shares ISA products side-by-side. You can apply online right through them if you so desire.
Money Saving Expert - Here you will find the complete guide to investing in ISA's. There is lots of helpful information on this site that you will not find in other places.