In the UK, one of the most generous allowances for the ordinary saver is that available on Individual Savings Accounts (ISAs).
At a time when interest rates have barely been hovering above zero and investors have had to grow accustomed to low rates of return on their money (due to the effects of the Lehmans crash and the 2008 credit crunch), it’s important that you leverage any tax breaks that are available.
Receiving investment income that’s exempt from income tax will immediately save you 20% if you pay at the basic-rate, which gives your investment a head start.
What is the 2019/20 ISA allowance?
The ISA allowance for the 2019/20 tax year is £20,000. This means you can pay up to £20,000 into an ISA without incurring any tax liability on the income the investment earns, or on capital gains through any increase in its value.
If you leave income in the ISA to be added to the capital, the compounding effect makes it a powerful investment tool.
Where can you allocate your ISA allowance in 2019?
You can invest into one of each kind of ISA each tax year – as long as you do not exceed the annual ISA allowance.
There are seven types of ISA, the main four being;
- Cash ISAs
- Stocks and Shares ISAs
- Lifetime ISAs
- Innovative Finance ISAs (IFISAs)
A Cash ISA is made up of cash savings and, as such, is one of the safest forms of investment. Cash ISAs are not at the mercy of market conditions – other than inflation – and are not based on a business which could fail.
However, the price of security in investment is usually lower returns and, as we’ve mentioned, interest rates are at historical lows and are barely keeping pace with the rate of inflation.
Stocks and Shares ISA
Stocks and Shares ISAs, on the other hand, contain investments in equities and have the potential for a higher rate of return in capital gains - if the value of the shares increases - and in dividends.
Another benefit of the Stocks and Shares ISA is that you can sell the assets held in your ISA at any time and there is no minimum length of time you need to hold it. However, if you do cash in some or all of your ISA, you can only reinvest this money into another ISA to the extent that you have unused available ISA allowances.
The flip side of this is greater potential risk. The value of stocks and shares will fall if the business behind them does badly and, even if the business is sound, the shares could still lose value in the event of a general market downturn.
It’s true that over the longer-term, the value of stocks and shares tends to rise. But, there can be some sharp falls along the way, and investors can get their fingers burnt.
Investment is all about balancing risk and return.
Innovative Finance ISA (IFISA)
Now, an investor who is looking for ways to use their ISA allowance in 2019/20 has another option - the IFISA.
The IFISA was introduced in 2016 as a way of extending the ISA tax umbrella to the growing peer-to-peer (P2P) lending market.
In terms of risk/return profile, IFISAs sit between Cash ISAs and Stocks and Shares ISAs.
With an IFISA, you can take advantage of the opportunities presented by some of the high growth businesses raising funds through the P2P lending sector. The returns from these are often higher than the rates provided by Cash ISAs.
While better than cash, these returns tend to be lower than those available from Stocks and Shares ISAs, but they can be safer due to many being asset-backed.
They’re in the form of loans and debt-based securities, so they have a fixed value which isn’t subject to market conditions, and they pay a target rate of return which isn’t affected by company performance.
Of course, there’s always the danger that the business that borrows the money could fail, but many of these IFISAs can be used to invest into asset-backed bonds - such as property bonds - which can be secured against property assets.
The downside to IFISAs is that returns are not guaranteed. Should there be a market downturn, this could have a negative impact on investments.
It’s also important to note that rules imposed by the Financial Conduct Authority (FCA) mean that everyday investors are only able to put up to 10% of their available assets in the P2P lending market. This is to better protect investors from placing large amounts of money into investments that they may not fully understand.
How can you diversify your ISA portfolio?
Achieving all-important portfolio diversification is relatively easy with ISAs due to their sheer variety.
Using the different types of ISA, you are able to spread your investments across the main asset classes - including cash, fixed interest instruments (bonds) and shares. For example, you can invest in shares using a stocks and shares ISA, you could use an IFISA to invest in property bonds, and you could deposit cash into a Cash ISA - all within the same tax year.
A great ISA portfolio will include a good mix of these asset classes in order to minimise volatility and reduce risk.
So, to round-up - when deciding how to use your ISA allowance in 2019, you’re spoilt for choice. It’s clear that, using ISAs, you have the ability to achieve a well diversified investment portfolio. By now, you know your ISA options, but it’s important you consider speaking to an independent financial advisor to find out which investments are best for you and your risk profile.
Your capital is at risk. MAVEN Bonds are asset-backed but an economic downturn could affect returns and you may not get back the amount invested. In the event of default the security held doesn't guarantee the return of your capital. Enforcing your security may take time and your returns may be delayed. Investment is not covered by the Financial Services Compensation Scheme (FSCS).
Originally published 1st July 2019, updated 12th November 2019.