Stocks and shares Isas: how they work
Notwithstanding any surprise moves by the Bank of England, March 2016 will mark the seventh anniversary of interest rates being stuck at their historic low of 0.5%.
Savers have witnessed banks and building societies slash their deposit rates to typically negligible levels. And many commentators don’t believe rates will rise significantly for several years. So plucky savers tired of enduring paltry rates of return from their cash Isa may need to up the ante and move into the stock market if they want to get their money working harder for them.
Over recent years it appears investing has become the new saving, as a greater number of people seem to be diving into the stockmarket.
Numbers from HMRC show that by the end of the 2014/15 tax year, there was more than £170 million invested in stocks and shares Isas across the country, up from some £80 million in 2008/09.
While a cash Isa is merely a tax-free savings account, a stocks and shares version gives you the opportunity to invest your money in stock markets worldwide. Investing comes with its fair share of risk, as returns will fluctuate and would-be investors need to ensure they are happy to put their money away for the long term, with the rule of thumb saying this should be at least five years. But the rewards can potentially be considerable.
Maike Currie, investment director for personal investing at Fidelity International, says: “For anyone who is unsure on whether stocks and shares is the way to go or whether they should stick their savings in cash, our calculations show that if a saver had invested £15,000 into the FTSE All Share index over the 10-year period from 31 December 2005 to 31 December 2015, they would now be left with £25,768.
“If, however, they had invested £15,000 into the average UK savings account over the same period, they would be left with £16,096. That’s a difference of nearly £10,000 – too big for anyone to ignore.”
A stocks and shares Isa is simply a tax-efficient account or ‘wrapper’ for which you can choose the underlying investments. All UK residents aged 18 and over are entitled to an annual stocks and shares Isa allowance of £15,240 for the 2015/2016 tax year, but don’t have to invest the full amount.
If you are saving and/or investing and not using your annual allocation, you are just giving the taxman more of your cash than you actually need to. When you save and/or invest outside the Isa wrapper, if you are a basic-rate taxpayer you are hit with a 20% tax charge on any interest on your investments, rising to 40% for higher-rate taxpayers and to an even heftier 45%, for those in the top bracket.
Any growth on your investments is subject to capital gains tax of 18% or 28% when you sell them, although individuals have an annual capital gains tax-free allowance of £11,100 for 2015/16.
But you can invest up to £15,240 in an Isa, in the 2015/16 tax year, and all your capital gains are free from the clutches of HMRC, so use as much of the current allowance as you can.
While £11,100 a year sounds like a decent capital gains allowance, it could change in future. The only snag is that income derived from dividends – profits which companies share with their investors – are hit with a 10% tax at source that you can’t claim back through an Isa.
As in the case of cash Isas, you have until the end of the tax year, 5 April, to open an account and invest the money. If you do not take advantage of your allowance, you will lose it as it cannot be rolled into the next year.
Importantly, though, you can split as much of the allowance as you like between investments, cash, or any mixture of the two, so you do not need to take on any more risk than you are comfortable with. As is the case with cash Isas, you can opt between putting away lump sums as and when you wish into the account and/or making regular contributions.
From an investment perspective, you are perhaps better drip-feeding your money into the market on a regular basis rather than throwing in large sums, as it helps your money to ride out any market volatility.
Remember, too, that an Isa allowance is allocated per individual, so for a couple this year’s allowance is a decent £30,480. You can also invest for your children in a Junior Isa, or Jisa, where the same tax advantages apply but the limit is set at a far lower £4,080.
If you already have a cash Isa, under new rules you can now transfer your money over to a stocks and shares version, you do not need to sell up and then reinvest. To switch providers, contact the Isa provider you want to move to and fill out an Isa transfer form to move your account. If you withdraw the money without doing this, you won’t be able to reinvest that part of your allowance again.
What can I put in?
You can put a wide range of different investments into your stocks and shares Isa, including company shares and/or bonds – the latter are IOUs issued by governments and corporations looking to raise cash, which pay a fixed rate of return. For the most part, however, and certainly for novice investors, funds are a better option. These are pooled investment schemes, run by professionals who pick a broad number of investments on behalf of their investors.
Funds, also referred to as unit trusts or OEICS, come in all shapes and sizes. They can invest in, say, the UK market, while others invest globally. Some just invest in stocks; others in bonds; and there re those, sometimes dubbed multi-asset funds, which hold both, as well as other investments such as commercial property.
The advantage of investing in a fund is that your money is spread over a variety of investments, so all your eggs don’t sit in one basket.
While fund management groups sell Isa wrappers for their own funds, as do some banks, these tend to be more expensive and you will typically be restricted to only holding products from that manager within your Isa. The vast majority of people tend to buy an Isa via a fund platform - an online fund supermarket such as Hargreaves Lansdown, The Share Centre of Interactive Investor. These platforms allow you to pick and choose from a vast selection of investments from different providers.
Justin Modray, founder of Compare Fun Platforms, says: “Using an investment platform allows you to mix and match from a wide range of different fund managers within a single Isa. The downside is that investment platforms charge for their services but, even so, it is still likely to be cheaper overall versus buying from a manager directly.”
Platforms tend to suit DIY investors happy to make their own decisions in terms of choosing where they want to invest. The vast majority of fund platforms also provide plenty of free online guides to help you choose funds to suit your risk appetite and investment goals.
What are the costs?
You could go via an independent financial adviser but they typically tend to only deal with individuals with more than their annual Isa allowance to invest, usually around the £50,000 mark, and they will charge you either a percentage fee of the amount you want to invest, or an hourly rate.
Platforms tend to charge an annual fee, either as a percentage of your Isa value with no fund dealing fees or as a fixed amount with additional fund dealing fees. Percentage fees tend to work out cheaper for Isas below around £50,000 a year, while fixed fees start to become better value above this, depending on how often you will trade funds.
In terms of the best value platforms, Mr Modray highlights that Cavendish Online and Charles Stanley Direct, offer the lowest annual platform fee at 0.25% a year, which can be cost effective for smaller portfolios and when starting out. He adds that Interactive Investor can be good value for a fixed-fee platform, with an £80 annual fee that includes two free trades
a quarter, with additional trades charged at £10.
But these are just the platform and dealing charges for the wrapper; you will pay for the funds you invest in, too. Check the ongoing charges figure (OCF) or Total Expense Ratio (TER), to get an idea of what you will pay every year.
For actively managed funds, where a fund manager is buying and selling stocks on behalf of investors, you should not pay more than around 1% a year. For tracker funds, which echo the performance of a particular market or index, such as the FTSE 100, you should not pay more than 0.1% to 0.2%.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Total expense ratio
Most investment funds levy an initial charge for buying the units/shares and an annual management fee but other expenses also occur in running the fund (trading fees, legal fees, auditor fees, stamp duty and other operational expenses) which are passed on to the investor and so the TER gives a more accurate measure of the total costs of investing. The TER is especially relevant for funds of funds that have several layers of charges. Unfortunately, investment fund companies are not obliged to reveal TERs and many only publish the initial charges and annual management charge (AMC).
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.
The ISA rules allow investors to transfer money from an uncompetitive savings account with one provider into one from another provider that pays a better rate of interest. The bank to which you are transferring the money must do the transfer process, as withdrawing the money from the ISA wrapper means you lose the tax-free status. You can transfer a cash ISA into a stocks and shares ISA, but not the other way around and the current tax year’s cash ISAs must be moved whole to a single provider, but previous years’ ISAs can be split between new providers.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.