Over the last month or so you may have noticed many adverts in the windows of banks and building societies, or adverts in newspapers from financial institutions encouraging us to use up your Individual Savings Account (ISA) allowance prior to the end of the financial year.
The amount of money invested in ISAs always peaks in the run up to April 5 - the end of the tax year - as savers rush to use up that year's allowance. But there are plenty of good reasons to start thinking about your ISA much earlier on.
The phrase better late than never may be overused, but as is the case with many clichés, it has become one because it is true. This certainly applies to ISA investing, as it's much better to invest at the last minute than not at all, otherwise the tax benefits of Cash and Stocks and Shares ISAs will be lost – ‘you use it, or you lose it’.
However, another popular saying - a stitch in time saves nine - equally applies to ISAs.
Investing earlier in the tax year means that the money is working for longer; earning interest in the case of a Cash ISA and potentially generating capital growth and receiving dividends for a Stocks and Shares ISA.
Technically, an ISA is not an investment in its own right. Perhaps the best way to think of an ISA is as a ‘wrapper’ in which you can shelter savings and investments from tax. Within an ISA you pay no Capital Gains Tax and no further tax on income. You don’t even need to declare ISAs on a tax return, and less tax means greater returns for you.
The maximum you can invest into an ISA for the 2012/2013 tax year is £11,280. Up to £5,640 of this can be in cash, which is essentially a bank account sheltered from tax. However, if you’re prepared to take more risk, you can invest up to the whole £11,280 into a Stocks and Shares ISA. This greater capital risk this can lead to greater returns over time, but there is also a risk of capital loss too.
If you have a pot of cash sitting in a standard savings account you may be better putting it into a Cash ISA to make the most of the rates and tax breaks and with most ISAs there's nothing to stop you making regular contributions throughout the year if you haven't got a lump sum available.
In the case of Stocks and Shares ISAs, there is also strong argument for making regular payments. If you invest a lump sum, it may be at a time when the share prices are high, meaning that you could get less for your money than you would do when prices are lower. Making regular payments into a Stocks and Shares ISA can smooth out these price fluctuations.
Drip feeding money into a Stocks and Shares ISA is often effective, because you're benefiting from what's known as the pound-cost averaging effect, which reduces the risk of investing a lump sum shortly before a market fall.
Whilst it would certainly be bad luck to invest the day before a crash, trying to time the investment to the point where markets are low is very tricky - it’s extremely difficult to try to work out when peaks and troughs in the market are likely to occur.
Regular investments can be set up via a direct debit, or alternatively, some ISA providers will take a lump sum from you and feed it into the chosen product over a specified period of up to a year.
I’ll sign off with one last financial adviser cliché, ‘it’s all about time in the markets, not timing the markets’.
Investment values can fall as well as rise and you may get back less than you invest.
Financial Planning Consultant
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