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Funds vs Shares: How Should You Invest Your ISA Allowance?

There is great debate among investors and financial services professionals about whether buying shares in companies or units of funds is a better idea. Clearly, there are advocates for both sides of the argument and, now that you will have another £15,240 to invest in either (or both) through your ISA, it seems to be a good time to revisit the question.

Diversification

While it is possible to gain access to a wide variety of companies in different sectors, which operate in different regions, and that are of different sizes, funds allow you to have far more diversification than do shares. In fact, even if you invest all of your cash in just one fund, you are still likely to have more diversification than you could achieve through shares alone. For example, you may wish to invest in UK-listed companies and, while your portfolio may contain 20-40 stocks, a fund could have literally hundreds of companies included within it.

Costs

Shares, however, are a much cheaper way to invest in the long run. For example, you can invest for as little as £2 per trade (using aggregated orders), which means that even if you buy 40 stocks with this year’s allowance, you will still only pay £80 in your first year in dealing charges. This works out as just 0.5% of the annual allowance, which is the same as stamp duty and, moving forward, the only other cost will be to sell the shares a number of years down the line.

Funds, however, can charge much more. For example, even a tracker fund will charge upwards of 0.35% per annum, while an actively managed fund will typically charge 1% or 1.5% per annum. So, assuming you invest £15,240 right now and nothing else for five years, and the value of your portfolio remains at the initial level throughout the period, you will pay £266 in total for a tracker fund and up to £1143 in total for an actively managed fund. That’s significantly more than the cost of dealing in shares and, for many investors, is a deal breaker.

Performance

Clearly, the people running funds are professionals and, in general, they will be more knowledgeable than part-time, private investors. However, there is still no clear cut evidence that fund managers, in general, outperform private investors in the long run once the cost of their services has been deducted. So, if it’s better performance you’re after, then funds may not be the answer.

Time

Of course, it is often argued that funds require less time than shares, with investing in companies needing vast amounts of research and funds requiring relatively little. However, some funds are better than others, just as some companies are more appealing than others, and so, realistically, you are likely to spend just as long finding the right fund manager as you are the right stocks. Certainly, logic says that you should be spending at least as much time performing due diligence when you trust someone else with your hard-earned cash as you do when you are making your own investment decisions.

So, while funds do make diversification easier, in today’s internet age buying shares is so straightforward, cheap and information is so freely available that for most investors buying stocks with their ISA allowance could be the most appealing option. Certainly, mistakes will occur, but with patience and a long term view you can start to build a comfortable retirement through buying slices of high quality companies with this year’s ISA allowance.

And, to get you started, the analysts at The Motley Fool have written a free and without obligation guide called 5 Shares You Can Retire On.

The 5 companies in question offer stunning dividend yields, have fantastic long term potential, and trade at very appealing valuations. As such, they could deliver excellent returns and provide your ISA with a major boost in 2015 and beyond.

Click here to find out all about them - it's completely free and without obligation to do so.