1. ISAs offer amazing tax advantages
Before we consider why you should set up a Stocks and Shares ISA, you might ask why open an ISA at all? The answer is that ISAs are special vehicles set up by the British Government to encourage more saving and investing. They do this by allowing capital and income gains on ISA investments to be free of tax. This tax-free status can add up to a big saving over time, compared to normal deposit accounts or funds held outside of an ISA. But you must open your ISA to benefit.
2. Use your full allowance every year
The UK government allows every British citizen over 18 years of age to put £7,200 into an ISA every year. This can be split between a Cash ISA and a Stocks and Shares ISA. If you can afford to put £7,200 in you should, as you can’t claim back your allowance from past years. Even if you’re not ready invest in the stock market, you should move as much of your cash savings into an ISA as possible every year. You can then transfer cash accumulated in ISAs to a Stocks and Shares ISA when you’re ready.
3. Realise that the ISA is a ‘wrapper’
Many people will tell you they have ‘got an ISA’ but they can’t tell you what that actually means. An ISA – also known as an Individual Savings Account – is a wrapper into which you can put permitted investments. For instance, you can hold cash, bonds, stock market funds and shares of individual companies in ISAs. The performance of your ISA is determined by what it contains – the ISA ‘bit’ simply ensures that the gains and income are tax-free.
4. Stock markets grow faster than cash and inflation over time
Why consider a stocks and shares ISA rather than staying in cash? If you’re setting aside money for the long-term, the stock market is the place to be. Over the long-term, the UK stock market has returned almost 10% a year, compared to less than 5% for cash. Over time this makes a huge difference to your returns. For instance, if you saved the full £7,200 into a cash ISA every year and enjoyed an average interest rate of 5%, you’d have £250,000 after 20 years. Not bad. But if you achieved 10% in a stocks and shares ISA, the same contribution would have grown to £453,000. Take inflation into account and the results are even more compelling, since most of the cash returns will in reality be eaten up by an inflation rate of 3%.
5. Use a tracker fund for your ISA, not an expensive managed fund
It has long been proven that most fund managers fail to beat the stock market over time. Worse, they charge you fees. You’re therefore best off putting your ISA allocation into an index-tracking Stocks and Shares ISA, which will ensure you match the stock market’s performance, minus minimal fees. Several well-known British companies offer index-tracking ISAs. You’ll see much more marketing for managed fund ISAs from banks and financial advisors, however, since they make more money for them (not you), so beware.
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