Let’s be honest: for what they offer, ISAs are amazing. And every year, millions of savers and investors take advantage of the £20,000 generous ISA allowance to protect their hard-earned cash and investments from the taxman. However, there are also risks, and many people make mistakes when it comes to their ISA.
Here I take a look at three of the most common ISA mistakes and how to avoid them on your way to financial independence.
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1. Selecting the wrong ISA
There are different types of ISAs that serve different purposes:
- Cash ISAs and easy access cash ISAs are great if you’re likely to need access your money within the next five years while still sheltering your interest from the taxman.
- Stock and shares ISAs offer greater returns but are also riskier because you invest your money in the stock market. Note that capital is at risk and you can get less than you put in.
- Lifetime ISAs are geared towards first-time buyers and offers a 25% bonus from the government.
- Innovative finance ISAs allow for peer-to-peer lending but come with a higher risk.
So, which one do you go for? This is a very simple question, but it can be a hard one to answer. This leads to one of the most common ISA mistakes. So if you are not clear about your financial circumstances and goals, essentially, you are running the risk of selecting the wrong ISA for you.
To avoid this pitfall, there are a few things you can do before opening an ISA. Consider how long you can lock your money away for. Also, consider your risk tolerance and how comfortable you are with potentially losing some money in pursuit of higher gains.
A good strategy is to spread the risk between different types of ISAs but make sure you always follow the ISA rules.
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2. Not diversifying your portfolio
Essentially, this means you should avoid putting all your eggs in one basket. I’m sure you’ve heard the saying before and understand why diversification is important. Essentially, spreading out your money across different investments is less risky than betting on a single one. For example, if you hold stocks in 10 different businesses, you’re less likely to feel the pinch if one of them experiences difficulties than if all your money is invested in only one.
This is why having a varied portfolio can help you out of this ISA blunder. Diversification improves the potential for long-term returns and reduces the chance of significant losses should an investment takes a turn for the worse.
Clare Francis, director of savings and investments at Barclays, says that over the years, she has managed to build quite a diverse portfolio, with money “invested in funds of different types and across different countries”.
3. Being put off by the size of the ISA allowance
Well, as things stand, the ISA allowance for the 2021-22 tax year is £20,000. While using the full allowance is definitely something to strive toward, it also has the potential to put people off. This ISA mistake is about thinking that you need £20,000 a year to make the most out of your tax-wrapper.
However, this is not really the case nowadays. You can start small by saving as much as you can comfortably afford. Mike Haslam, head of funds distribution at Barclays shares that most people, including him, cannot utilise their full ISA allowance every year. However, that doesn’t deter him from thinking long term by making smaller monthly contributions. This way, savers’ money will have more time to grow and potentially result in better returns.
Please note that tax treatment will depend on your individual circumstances and may be subject to future change. The content of this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. You are responsible for carrying out your own due diligence and for obtaining professional advice before making any investment decisions.
