David Prosser outlines five reasons to use investment companies in your ISA.
Time is running out for savers to take advantage of this year’s individual savings account allowance. You can use Isas to make up to £20,000 worth of tax-free savings and investments each tax year, but once the tax year comes to an end on 5 April, any unused allowance is gone for good.
For savers still mulling how to take advantage of Isas, the stock market might not seem an obvious place to put your money right now. Many world markets have spent recent years on an extended bull run, hitting record highs and delivering attractive returns; but the good times now seem to have come to an end, courtesy of the Covid-19 coronavirus, which has sent share prices tumbling. Maybe it’s best to play it safe with this year’s Isa allowance?
Well, possibly, depending on your circumstances, your savings goals and your attitude to risk. But amid the gloom, it remains as important as ever to focus on the basics. Stock markets can be volatile, but the pay-off for the rollercoaster ride is the potential to earn better returns over longer periods. If you’re making Isa investments you intend to leave untouched for an extended period – say five to 10 years, or more – the stock market’s historical record of outperforming other asset classes means it is worth considering, even during this period of ups and downs.
For most of us, that means a collective investment fund. A professionally-managed fund gives you the benefit of expert fund management, diversification, as your money is pooled with cash from other savers and invested in a pool of assets, and a hands-off approach that requires relatively little maintenance.
Investment companies, in particular, have several advantages for Isa savers building up stock market exposure, especially during volatile times such as now. These advantages include:
Retail investor platforms will allow you to invest a fixed cash amount each month, usually through direct debit, rather than having to put in all your money upfront. These schemes can work in your favour when the market takes a tumble: your fixed monthly investment then buys more shares in the fund, boosting your returns when the market bounces back.
Experienced fund managers
When markets are unpredictable and jumpy, you want someone looking after your money who has been through such times before. The average manager of an investment company has been in the job for almost 13 years according to analysis published recently by Morningstar. The average at other types of fund, by contrast, is only seven years.
Protection from the crowd
Stock markets are prone to panic; when tensions mount, investors sometimes rush for the exit – and even those staying put can get injured in the stampede. In certain types of fund, for example, the manager may have to start selling assets, potentially at knock-down prices, to pay investors who want to get out. Savers sticking with the fund for the long term therefore lose out too. However, the structure of an investment company means this isn’t relevant – investors buy and sell the fund by trading its shares on the stock market, with the underlying portfolio remaining untouched.
Cheaper entry points
One consequence of the structure of investment companies is that their shares don’t always reflect the value of the underlying portfolio – they often trade at a discount or premium to the value of the fund’s assets, depending on demand and supply. In more difficult times, discounts tend to widen, which can be an opportunity to get into an investment company at an attractive price. Indeed, shares in the average investment company currently trade at a discount to the value of its underlying assets of 9.3%; that compares to 3.8% at the beginning of the year.
Opportunities to spread your bets
For many Isa savers it will make sense to look beyond the stock market, particularly if you’ve predominantly invested previous years’ allowances in shares. Asset classes such as property, infrastructure and private equity all offer an opportunity to diversify – to invest in areas that are still capable of generating good long-term returns, but which don’t necessarily move up and down in line with the stock market. Often, these assets are illiquid, or only open to professional investors, but investment companies provide an accessible way in.