If you are growing a nest egg and want to make your money work harder, a Stocks and Shares ISA could be a good option. You could build on your savings without losing any of your gains to the tax office. If you open an ISA, your yearly allowance of £20,000 could help gradually turn your modest savings pot into a decent sum of money.
Contribute gradually rather than in lump sums
As the end of the tax period approaches each year, it can be a race for investors to pay into their ISAs before their annual allowance expires. According to the Financial Times, 97% of the amount invested in the tax year 2017/18 was via lump sums. If you don’t use it, you lose it, right? But why the last-minute rush? Surely, it’s better to think strategically and plan your ISA payments throughout the year, using a Direct Debit to deposit regular monthly payments into your ISA. This drip-feeding not only will it help you to make the most of your allowance, it also means you’re buying investments throughout the year at varying prices, which could mean better returns if you happen to buy cheap. Not to mention, the sooner the money is in, the longer it has to grow.
Why a gradual, long-term approach works
Long-term investing can be key to realising positive returns. By investing over the long-term, you’re giving your money more time to benefit from the power of compounding – when your returns generate further returns. Most available evidence based on how markets have performed in the past shows that remaining invested over a long period of time tends to pay off. For example, people who invested for any 10-year period since 1986 until February 2019 in the FTSE 100 index have had an 87% chance of realising positive returns on their investment – and that period includes three major market crashes: Black Monday, the Dot-com bubble and the 2008 financial crisis.
Put your money into a Stocks and Shares ISA
With a Stocks & Shares ISA, you can buy investments (e.g. shares, bonds, property, and commodities) and you don’t pay UK tax on any gains you make, so you get to keep more of your returns.
Here are some benefits to investing in a Stocks and Shares ISA:
You could get potentially higher returns than a Cash ISA
Since ISAs were introduced in 1999, the stock market has typically outperformed cash ISAs two-thirds of the time, and in 2017/18 those holding Stocks and Shares ISAs earned on average a 4.8% return compared to 0.97% for cash ISA holders. What this and similar research shows is that while the risk may be higher with a Stocks and Shares ISA, you could also see far higher returns than with a Cash ISA. It really comes down to how much risk you’re willing to take in pursuit of higher returns. The fixed interest rate of a Cash ISA is guaranteed but will only grow to a certain point. A Stocks and Shares ISA is not tied to any fixed interest rate and in effect, the sky is the limit for returns, but with it you accept a risk that your investments could also lose some of their value. In reality, even cash savings come with risk. Inflation erodes the value of your cash each year, so there’s a real chance it could be worth less over time if it’s not growing quicker than inflation is chipping away at it.
You can split your money between different kinds of ISA accounts
If you want to maximise your chances of good returns and spread your money over different ISAs, you can do just that with a Stocks and Shares ISA. It’s good practice to put some savings into an easy-access Cash ISA for a rainy day, then put any other savings into a Stocks and Shares ISA as part of a longer-term investment. If you have children, you could put some funds aside for a Junior ISA.
Beginner’s guide to investing in an ISA: Dos and don’ts
Here is a handy list of dos and don’ts for first-time investors. Take a look.
Do: make the most of your annual ISA allowance. You cannot carry unused allowance over to the following tax year!
Don’t: invest in things you don’t understand. In fact, stock picking is very risky, so unless you know what you’re doing, it’s probably safer to buy tracker funds that follow the market and spread your money across hundreds of well-known companies. Or use an online investment service that will make the decisions for you.
Do: keep an eye on your returns. While it’s not always true that the ‘grass is greener on the other side’, there may well be an investment plan out there that works better for you.
Don’t: take more risk than you’re comfortable with. A good place to start is ask yourself ‘could I afford to lose half of this money?’
Do: your research. There are a lot of misconceptions around investing, and you will be far more confident if you put them to bed.
Don’t: go into it thinking it’s a ‘short-term thing’. Five-years should be a minimum if you have something in mind for the money.
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