The ISA deadline (5 April) is fast approaching. Here’s why I think it’s so important to take advantage of the annual allowance.
Stocks and Shares ISAs: a good idea
A Stocks and Shares ISA allows us to avoid paying capital gains tax on profits made from our investments. Investing ‘careers’ can last for 40 or 50 years, so that could add up to hundreds of thousands of pounds.
This type of ISA also allows an investor to avoid paying income tax on any dividends they receive. Research has consistently shown that reinvesting cash returns can turbocharge returns. The less I return to the taxman, the better!
Another reason for using a Stocks and Shares ISA is that returns are likely to beat those offered by a Cash ISA. Right now, the latter offers just 0.5% at best in interest. Of course, investment returns can never be guaranteed (and building up an emergency money fund is a bad idea) but a Cash ISA won’t help me grow my investments.
Use it or lose it
One key point about the annual ISA allowance (£20,000) is that it has a time limit. In other words, I can’t roll over any of my 2020/21 allowance into the 2021/22 tax year. If I don’t use it, I lose it.
Given this, if I didn’t already have one, I’d open one today, rather than waiting until after 5 April. I could then invest up to £20,000 for this year and repeat that after April 5 using the next year’s allowance.
Every little helps
Not everyone will be able to invest the full allowance. Even so, I don’t think this should put anyone off. As little as £25 per month can help in building a nest egg. An annualised return of 7% over 30 years adds up to around £28,000 by 2051 (ignoring fees).
Returns could be lower or higher, of course. An annualised return of 10% on £25 per month over the same period brings the total ISA pot to around £49,000. Again, I’m ignoring fees.
Stock-picking
Picking stocks for an ISA portfolio is very personal. What suits one investor may not suit another based on their financial goals and risk tolerance. I’m adopting a quality-focused approach. I’m searching for companies with low debt and for those businesses capable of growing profits and generating consistently high returns on capital employed as they go. I won’t turn down a dividend, but I’m most interested in whether these cash returns can grow year-on-year. The actual size of the dividend is of less concern to someone like me who’s not dependent on making income from my investments.
Away from the numbers, the best shares to own in an ISA will arguably be those belonging to firms offering multiple products or services. Being a market leader or operating in a space with limited competition is also desirable. As the Brexit saga has taught us, there’s a lot to be said for buying shares in companies with a global reach too.
The length of time someone remains invested is also a key factor. If I invest £25 for 40 rather than 30 years, I’ll theoretically end up with even better returns: almost £60,000 (at 7%), almost £133,000 (at 10%) and a whopping £304,000 (ar 13%).
That’s the power of compounding over time. And that’s why using my ISA allowance is a priority for me.
