ISA season
As the end of the tax year approaches, David Prosser explains how to build a balanced, well-planned portfolio.
It’s that time of year again: just as retailers look forward to Christmas, so the financial services industry rubs its hands with glee as the new year dawns and the end of the financial year approaches. Each year without fail, fund managers and financial advisers begin banging the same drum: buy your ISA before it’s too late.
They’ve got a point. Everyone gets their own individual savings account (ISA) allowance each year – in the 2017-18 tax year, this is worth a very generous £20,000. And if you don’t use the allowance before the final day of the tax year on 5 April, it is gone for good – there is no way to carry unused ISA allowances forward from one tax year to the next.
In that sense, the financial services industry is entitled to its ‘buy now while stocks last’ marketing message. Nevertheless, the message is misleading: the implication, or even outright suggestion, is almost always that ISAs are investments – and that’s not the case at all.
Why ISAs aren’t investments
In fact, an ISA is simply a wrapper within which you can hold a range of different investments in order to shelter them from tax. There is no income tax to pay on investments held within an ISA, and no capital gains tax to pay on any profits you make on the holdings.
It isn’t as pedantic as you might think to point out that ISAs are not investments in their own right. The problem with the annual ISA season is that it encourages us to make poor decisions about what can be very large sums of money.
Good portfolio planning begins with setting objectives. Why are you investing? What are your targets? What might be the best way to achieve those targets? How prepared are you to take on risk as you aim for the returns required?
The answers to these questions will begin to determine what you do with your money. The aim should be to build a portfolio which is geared towards meeting your targets for the future while trading off risk and reward at a level with which you feel comfortable. That will mean building a diversified portfolio of investments that offers exposure to a range of different asset classes.
This sort of careful planning is a million miles away from an approach to investment that sees many of us choose a single fund once a year on the basis of the financial services industry’s ISA marketing campaigns. Investors who fall into this trap frequently don’t even think about what investments they’ve made in the past – and how what they’re now considering will fit in.
Diversification matters
The result is that too many people end up with poorly diversified portfolios that are likely to be significantly more volatile in the short term – and significantly less likely to produce returns aligned to their long-term savings goals.
None of which is necessarily to blame the financial services sector for the way the world works. In fact, since ISAs offer generous tax breaks – the value of which can be considerable over the long term – it’s important to remind people that the allowance can’t be rolled over.
However, the onus is on investors to look beyond the ISA hype to think a little more deeply about the choices they make.
Should you use your ISA allowance this year? Well, if you have cash to invest, it’s certainly worth considering taking advantage of tax-efficient opportunities such as this, and many good investment companies offer ISA wrappers alongside their funds. But don’t buy an ISA – rather, use your allowance to add to your portfolio in a way that helps you towards achieving your financial objectives while managing risk and reward in a way that suits you.
