ISAs are an excellent tool for long-term saving. At the time of writing, savers can put away £20,000 a year in a stocks and shares ISA, and invest this money how they wish.
There’s no income tax or capital gains tax applicable on any income or profits generated on the money inside an ISA wrapper. You don’t even need to declare it on your tax return.
Every single investor can benefit from opening an ISA. And if you’re planning to do just that, but don’t know where to invest your £20,000 savings pot, I think there are a couple of rules you should follow.
Slow and steady wins the race
Firstly, even though profits and losses inside an ISA are not subject to capital gains tax, I think it’s sensible to concentrate on buying investments for the long term, rather than trying to pick short-term bets. Yes, you might make more money by trying to trade the market, but as the ISA contribution is limited to just £20,000 every year, you cannot replace any money if you end up making a losing trade.
The best way to maximise your ISA allowance is, in my opinion, to focus on attractive long-term buy-and-forget investments.
With this being the case, I think it’s probably best to concentrate on picking blue-chip dividend stocks, or if you aren’t comfortable chosing single stocks, buying an FTSE 100 tracker fund might be a better option. Other options are available, including investment trusts, which cost a bit more, but offer a higher level of income.
The amount of money you devote to blue-chip stocks will depend on your own investing preference. I believe it could be best to devote the bulk of your £20k investment to these companies.
At the same time, it could be a good idea to target high growth stocks as well, although I don’t recommend trying to pick these stocks yourself. It’s better to choose a fund run by an experienced small-cap investor. Doing so will give you exposure to small-cap companies, which generally produce a better return than blue-chips over the long term, without exposing yourself to the risk of permanent capital impairment.
If you’re happy to have your entire ISA invested in stocks, I recommend investing around 75% in blue-chip stocks and 25% in small- and mid-cap companies (via funds).
If you’re not too comfortable with such a high allocation towards equities, bond funds can be added to the mix as well. Replacing the 25% allocation towards small- and mid-cap companies with bonds would impact long-term returns, but it would also reduce volatility.
The income option
At the moment, blue-chip stocks offer a higher level of income than most bonds. So, if it’s income you’re after, it might be better to have more money in blue-chips than bonds. Although, at the end of the day, the allocation you decide on really depends on how comfortable you are owning certain investments.
Personally, I’ve adopted the 75% blue-chip and 25% small- and mid-cap allocation. I’m satisfied with this level of risk and believe it will produce the best returns over the long term.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.