FOOL'S EYE VIEW
ISA Ins and Outs

By Christopher Spink
March 14, 2001

If you've never invested before, now is the time to dip your toe in the water. With weeks to go before the end of the tax year and the FTSE plummeting things couldn't be better. Honestly. You might think it mad to even talk about investing at the moment. But after the FTSE 100's fall of more than 6% so far this week now is actually a great time to buy shares, as they are cheaper than they have been for over two years.

One of the best ways of doing this is by picking up an ISA. Not only will any gains you make be tax-free but also you will have to adopt a long-term view because your money will be locked up in a fiddly and inflexible instrument, which is surprisingly hard to manage.

Think long term!

If you want to save money for the long run then ISAs make sense. In fact investing should only ever be done with a long-term perspective. Don't expect to see your savings soar inexorably skyward. As the past year has shown, you should be prepared to watch your investments dwindle in value for quite extended periods. That's why you need to have patience to put your cash aside for five years or more.

Everyone knows that ISAs protect your savings from any tax liability. With pensions the money you pay in is tax-free but you have to pay tax on the income you receive in retirement. But ISAs work the other way round. Whilst you will already have paid tax on the cash you put in, any gains you make from the investments wrapped in your ISA are free from any further tax charges.

That's all well and good, but their current complicated structure, involving Mini and Maxi versions and all sorts of varying investment possibilities, leaves much to be desired. What should the confused individual do to make the most of this tax-free treat?

Sort out your strategy

First you should sort out your strategy before buying one. Once you have committed funds to one maxi ISA then you won't be able to change your mind and open another in that current tax year. This has the desired effect of making you stick to your guns, preventing short-term panics.

First of all, then, work out how much money you have to save in each particular tax year. This could be any spare cash you have lying around, which you don't need immediately. Most people will have a plan to put aside a certain sum each month in a savings scheme of some sort. You only have 22 days left in the current tax year. So only if you have a spare sum to invest should you bother with an ISA before April 6th.

You can only invest £7,000 per year in an ISA. That works out at £583.33 per month. That's quite a substantial sum of money, when you consider average earnings after tax each month in the UK amount to £1,500. If you can put away a third of your income in a savings vehicle providing tax-free returns then you're doing well. Even 10% of your earnings is good.

Place your bets

Once you've decided how much you can save then you have to put it somewhere. The problem is that once you've committed funds to one particular maxi ISA then you can't take out another in that tax year. Of course you could go for mini ISAs. There are three varieties of these: cash, shares and insurance. You can put £3,000 into each of the first two and £1,000 into insurance mini ISAs.

Not many people provide insurance ISAs. Cash ISAs offer similar returns to high-interest savings accounts, except that this income is of course tax-free. However, if you go down this path then you severely restrict the amount of money you can put into shares, from £583.33 a month to £250 a month. Of course cash ISAs can be useful if you merely want to receive a tax-free income in retirement.

So: you have £583.33 a month to put in an ISA backing a variety of stock market investments. Most financial services providers offer the facility to save money regularly by this method. Go for an ISA that has low management charges of 1% a year or less. Perhaps the best and simplest are those that track the FTSE 100 or FTSE All-Share index. These will give you the market average.

If you want to try and do better than the average, then you can either pick shares or investment trusts yourself using a self-select ISA, or else go for a fund managed by a professional investor. You will have to pay higher fees for this market-beating attempt. Several financial services companies now provide fund supermarkets, allowing you to pick and mix the funds you can put in your ISA.

Keep an eye on your investments

Finally, remember to set up your savings schemes so that you have the flexibility to change your strategy at the end of each tax year. For example you may decide that in the 2001/2002 tax year you want to track the index in your ISA. But then in the 2002/2003 year you may want to choose shares via a self-select ISA. This is fine.

Just don't let inertia force you to stick with the same strategy if you're unhappy with it. This is something financial services companies hope you will do so that they can casually raise fees on funds to catch out lazy investors.

For more on ISAs, check out our comprehensive ISA Guide and the ISA discussion board.