MARKET COMMENT
To ISA or Not To ISA

By Bruce Jackson (TMFGoogly)
February 27, 2003

Welcome to ISA season 2003. For companies operating in the financial services sector, such as the Motley Fool, this annual 6 week event is very exciting. For us, Football World Cups, Cricket World Cups, Chelsea Flower Shows and Munich Oktoberfests have got nothing on ISA season. Well...maybe not the latter one - it is hard to compete with a 3 week festival where 6 million people collectively consume 5 million litres of beer - but you get the point!

Between now and the end of March, consumers will be bombarded with marketing material, encouraging them to sign up to the top performing, best of sector, Global High Growth Income Protected All Singing & Dancing ISA from Old Universe Investments, or some such fund.

However, before investors make the difficult decision of deciding which ISA fund to invest their hard earned cash, they first have to decide whether in fact they are actually going to get an ISA this year at all. With equity markets remaining in the doldrums, its probably not surprising that many investors are sitting on the sidelines. The FTSE 100 has started 2003 where it left off in 2000, 2001 and 2002 - down! War, oil prices, manufacturing gloom, house price bubble, consumer debt levels...the world economy is not looking too clever.

Given all that, the question remains...do I or do I not get an equity ISA?

The Pros

• On a dividend yield basis, at current levels, shares compare favourably to many other forms of investment. The FTSE All Share Index trades on a historical dividend yield of 3.8%, above base interest rates of 3.75%. The attraction with dividends is that they are expected to grow over the long term.
• History has shown that times of uncertainty have generally been good times to buy shares. Over the past 100 years, we've been through two world wars, hyperinflation, an oil crisis, a great depression, market crashes, wars in the Middle East, and one or twenty other ugly events. Yet, each time, the stock market has bounced back and set new highs.
• Using a self select ISA, you can choose your own shares. Several big and solid FTSE 100 companies have dividend yields above 5%. Some banks and life assurance companies are yielding between 6% and almost 10%. Although there is some danger of dividends being cut, a portfolio of high yielding blue chips should give you sufficient diversification, and safety.
• Tax - inside an ISA, any capital gains are free from capital gains tax, and any dividend income is tax free.

The Cons

• When investing in shares, you should have a long-term outlook. Only invest money into an equity ISA that you are prepared to leave for 5 years or more. If you are looking for a short-term punt, go down the bookies.
• The equity ISA fund you choose under-performs the market. According to a recent report from the performance monitoring company, WM, over the last 20 years, 80% of fund managers performed worse than the market. High charges are often to blame for this under-performance. The lower the risk of under-performance, the Motley Fool has long been a proponent of the low cost index tracking fund.
• Stock markets continue to fall. With an equity investment, this is always a risk. History has shown that the market has risen over long periods of time, so if you believe history will be repeated, you may feel confident taking that risk and investing now. You could consider dripping money into your ISA, taking advantage of pound cost averaging should shares fall in the short-term.

So there it is. There are probably a couple more pros and cons, but the above should sum up the main points.

As for me...well, I'm a long-term stock market investor. This ISA season I'll either continue my regular monthly investments into my index tracking fund, or I'll take out a self select ISA and try my luck at out-performing the market returns. Whatever you choose, good luck!

For more information on ISAs see ISA Centre ¦ Self Select ISAs ¦ Index Tracking ISAs