In the run-up to the final day of the tax year, David Prosser discusses best practice in deploying ISA savings.
Are you currently worrying about how to use your 2018-19 £20,000 individual savings account (ISA) allowance before you lose it for good? If so, you’re in good company – the run-up to the final day of the tax year on 5 April each year always concentrates people’s minds. Suddenly, they remember that Isas are a time-limited opportunity; the value of funds invested through Isas during March and the first few days of April always spikes sharply upwards as a result.
Here’s the thing though. As well as being unnecessarily stressful, this approach to investment rarely produces the best results. For one thing, rushing to beat a deadline is not conducive to making well-considered decisions on the basis of your attitude to risk, your financial needs and goals, and the investments you have already made.
Moreover, by leaving it late to invest, your money has less time to work on your behalf: the laws of compound interest mean that assuming the cash earns positive returns, the last-minute approach will deliver a less happy end result. All other things being equal, you’ll be worse off if you leave investing to the last minute.
The cost of last-minute Isa investment
Numbers crunched by Fidelity reveal the effect can be much more significant than most people realise. It worked out how much two investors would each have today, if they’d invested their full Isa allowance each year for the past decade and then earned a return equivalent to what the FTSE All-Share Index, which measures the performance of the UK stock market, has delivered over that period.
Investor number one, who used their Isa allowance in full on the first day of each tax year would today have a portfolio worth around £145,000. By contrast, investor number two, who waited until the final day of the tax year to investor, would now be sitting on £136,000 or so – in other words, they would be £9,000 worse off despite having made exactly the same amount of savings.
The lesson of those figures is that March and April should be the time when you’re thinking about how to use next year’s Isa allowance, rather than rushing to use your allowance for the year coming to an end. If you’re currently focused on her 2018-19 tax year, that’s fine, but why not use this opportunity to think about 2019-20 at the same time.
How to get ahead
Clearly, not everyone is in a position to invest their full £20,000 Isa allowance right at the start of the year. However, the sooner you can get your money working on your behalf, the better – either by investing your lump sum at the beginning of the tax year rather than the end, or by consistently drip-feeding cash into your savings over the course of the year.
The latter option is simple with the regular savings plans that most investment company managers offer. These enable you to save as little as £50 each month in your chosen funds, rather than using the whole allowance in one go, so that you can begin investing straight away.
Fidelity’s data shows the positive effect of the regular savings model. On the same basis as the example above, the drip-feeding investor would today have £142,500 in their account – not far behind the first-day investor and more than £6,000 ahead of those who left it to the last minute.
Drip-feeding also has the added advantage of giving you access to pound-cost averaging. This is the statistical quirk that smooths out stock market volatility over time – the idea is that in months when your fund has fallen in value, your fixed month investment buys more shares or units in it, adding to the value of your holding when prices recover.
The bottom line is that you should try not to let tax incentives determine your investment behaviours. Invest in the assets you put in an Isa because they’re the right assets for you – and do so at your earliest opportunity, irrespective of the end-of-tax-year deadline.