| Real Life Strategies for Building Wealth

Keep reading and you’ll learn:

  • What is a stocks and shares ISA?
  • Why is a stocks and shares ISA good investment?
  • Who can benefit from investing in an ISA?
  • How to decide which investment ISA is for you?
  • Underplayed rules of ISA you must know.

You finally have some spare money in the bank.

Do you keep it in a savings account? Do you put it in a stocks and shares ISA? Cash ISA? Or do you buy your dream car?

Your mind goes around in circles and you simply cannot decide. You know that keeping your money in a cash ISA is no better than leaving it to gather dust, and gently but surely reduce, in your savings account. You really want to use this money for your future, not squander it.

You have heard about investment ISAs and find them confusing – try as you may, you can’t decide which is the best ISA for you.

You cannot decide.

You are terrified that making the wrong choice will lose your money and kill your future.

You are paralysed by fear and confusion.

You realise that investing is a good idea and you don’t know enough about it to make the first step.

I understand. This is how I felt six years ago. Do you know what I did about it?

I learned about investing and learned about stocks and shares ISA first; because using the tax advantages investment instruments offer is a sacred rule of building wealth. When I knew enough, I chose the best ISA for me, opened an account and started contributing.

Yes, I understand. In this post, I gift you my knowledge and experience of stocks and shares ISA – so that you could learn enough to be able to select the best ISA for you and act.

Here you’d learn:

  • What is a stocks and shares ISA?
  • Why is a stocks and shares ISA good investment?
  • Who can benefit from investing in an ISA?
  • How to decide which investment ISA is for you?
  • Underplayed rules of ISA you must know.

What is a stocks and shares ISA?

An individual savings account (ISA) is an arrangement available to individuals in the UK who qualify for favourable tax status. This means that contributions to the account are made from after tax income, but these are not subject to income and capital gains tax; no tax is paid on money withdrawn from the account either.

It may make it easier to think about ISA (in general) as a nice wrapping paper you could place around your cash savings (Cash ISA), savings to buy a house (Help to Buy ISA), stocks and shares investments (Stocks and Shares ISA) etc. Currently, there are six different types of ISA and numerous possibilities within these. You can learn more about the different types of ISA by reading this guide to ISA.

Stocks and shares ISA uses tax-free paper to wrap your stocks and shares investments.

Among the ISA family, I’m most partial to stocks and shares ISA and to Innovative Finance ISA.

Stocks and shares ISA holdings

When it comes to what you can hold in a stock and shares ISA, you have considerable flexibility. Here is a list of the holdings you can stash in an investment ISA:

  • Cash. You can hold cash in your ISA while deciding what to invest it in; otherwise it is not worth it.
  • Unit and investment trusts (should be careful with these because there are conditions the trusts must meet).
  • Individual stock and shares. If this is your investing game, you can place individual stocks and shares in your ISA. They must be traded on one of the recognised stock exchanges.
  • Index funds. Index funds are portfolios of shares in companies that represent a segment of the market (e.g. S&P500, FTSE100 etc.).
  • Exchange Traded Funds (ETFs). ETFs are a basket investment that comprises stocks, commodities, bonds etc.
  • Government and corporate bonds. These are public debt securities.

Don’t panic! Most investment ISA providers offer help with understanding, and selecting, these options.

Annual ISA allowance: how much and how to use

The annual, tax-free ISA allowance can change from year to year. For the year 2019/20 it is £20,000.

Ideally you should max your ISA allowance. Still, this is a lot given that we are talking about an individual account – ISAs cannot be shared.

Your total ISA allowance for a year is £20,000. You can divide this between:

Why is a stocks and shares ISA good investment?

There are so many investing options to choose from that it is easy to lose our way in them. My rule for investing, particularly for beginner investors, is simple:

  • First, contribute all you can to your pension. (We will talk about this one some other time)
  • Second, max out your ISA allowance.

All other investments come after these two.

Now, let me tell you why stocks and shares ISA is a good investment and you should max it out before looking elsewhere.

In brief, investment ISAs are good investment because they are:

  • Tax efficient;
  • Liquid (largely) and flexible;
  • Psychologically hard to ‘violate’; and
  • Easy for beginner investors.

Stocks and shares ISA is tax efficient

Tax evasion is morally bankrupt. Making sure your money affairs are conducted in the most tax efficient manner is smart.

This is where, investing in an ISA is hard to beat. (You can check out this comparison between a stocks and shares ISA and a SIPP account, if interested. If you are short of time, I can tell you that in the long run ISA wins.)

ISAs are tax efficient in two ways:

  • When you keep within the tax-free ISA limit, which is £20,000, any investment returns, and dividends, are not taxed.
  • There is no tax when you withdraw money from your ISA.

Yes, I know that you contribute after tax income but still – as investments go – an ISA is very tax efficient.

Stocks and shares ISA is liquid and flexible

Stocks and shares ISA is a very flexible investment vehicle.

Your choices are many.

  • One choice you’ll have to make is about what to include in your ISA –value and dividend stocks, ‘basket’ investments like ETFs and Index Funds, mutual funds or bonds.
  • Another choice is whether you’d like to tinker with the content of your stocks and shares ISA yourself or you’d rather delegate its management to the experts (will get back to this one later).
  • Do you prefer fully managed ISA or you’d rather have a fixed allocation one?
  • And you ought to select an investment platform for your ISA.

Apart from that, you can transfer your stocks and shares ISA were you to find a better provider or your requirements change over time.

What is important is that you don’t exceed the annual tax-free ISA allowance. Most else is flexible enough to accommodate even a fussy investor.

Stocks and shares ISA is hard to ‘violate’

How often have you ‘violated’ your savings account in the past?

You know what I mean, don’t you? You have a bit of overdraft and pull some money out of your savings.

(I do this when life throws me a money curve ball.)

It is a bad idea to do this with investment ISAs – or any ISAs for that matter.

Okay, it is technically possible and, in the case of stocks and shares ISA, could take up to 30 days to complete. Still, this is an obviously dumb money move because:

  1. a) investments in a stock and shares ISA take off after about five years; and
  2. b) once you withdraw money, you cannot replace within the same tax year thus wasting the tax advantages the instrument has given you.

Stocks and shares ISA is hassle free and great for ‘beginner investors’

Many digital wealth managers offer ‘off the shelf’ stocks and shares ISAs. If you don’t have much experience with investing and would like your money to do better than lose 2% per year in a savings account, including in cash ISA, you can still start investing. Just look at stocks and shares ISA providers like Nutmeg, Scalable Capital and Vanguard.

Who can benefit from investing in a stocks and shares ISA?

Any investing in stocks and shares, including dressing this investment in an ISA, benefits people who can:

  • Control their fear and continue investing when markets go down; and
  • Stay for the long run.

Investing in stocks and shares is generally long term.

This is because of the fluctuations in the stock market we have come to expect.

Research shows that a dip in the value of the stock market of up to 10%, or corrections, should be expected at least once a year. Dips of up to 40%, also known as a ‘bear’ market, usually occur once every four years or so.

Scary stuff, right?

Not really. History shows that the market recovers from a correction within weeks and from a ‘bear’ within months. You must forget your fear and stay invested.

I’d say that the minimum timeline for stocks and shares ISA investing is five-six years.

Investing in an ISA can benefit specifically:

  • UK residents;
  • Experienced investors using the tax advantages if ISA;
  • Beginner investors making use of managed funds and digital wealth managers.

How to decide which investment ISA is for you?

There are many decisions to make when crafting the right ISA for you. In this section, we’ll discuss these in order.

Investment ISA providers

Many financial institutions offer investment ISAs. These roughly fall within four groups:

  • Banks. While banks offer stocks and shares ISAs, they tend to rank poorly for customer satisfaction according to this Which review.
  • Premium fund supermarkets. Biggest players are Hargreaves Lansdown and Fidelity Personal Investing. Originally these providers offered access to a range of investment funds; lately they have expanded and offer shares and corporate bonds.
  • Stockbrokers. These providers come from the stockbroker tradition (e.g. Interactive Investor) offering resources for stock pickers. One thing to watch for with this group of providers is their fees – they charge a stockbroker commission on top of the account fee.
  • Digital Wealth Managers. These are also known as robo-advisors and their distinguishing characteristic is that they use AI, or other form of automation, to build and balance investment portfolios. Best known providers in this group are Nutmeg, Scalable Capital and Moneyfarm.

Vanguard as one of the worthy providers of stocks and shares ISA though it doesn’t fit neatly in any of the four groups mentioned above. You can select what you place in your ISA from a large number of index funds (both stocks and shares and bonds) or opt into one of the pre-set portfolios.

Deciding the holdings in your ISA

Deciding what investments to place in your ISA depends on your experience, how much time and resources you are prepared to dedicate to managing your ISA investment, and the platform you select to host it.

If you have a history of success with dividend and value stocks investing and are a hands on investor dedicating considerable time to managing their portfolio – or prepared to pay a hefty sum to someone to manage it for you – by all means choose individual stocks.

If, on the other hand, you lack experience and/or favour more passive investments your choice must be index funds and ETFs.

Similarly, the mix of stocks and bonds would largely depend on how much risk you can stomach – the higher the risk, the lower proportion of bonds your portfolio would contain.

Investment ISA management

Here you have three choices, really.

You could decide to manage your ISA investment yourself. This option earns full marks for taking responsibility. The downsides are that you need considerable experience to succeed. Also, you need to dedicate considerable time to researching your investments and rebalancing your portfolio.

You can opt to have fully managed investment ISA and outsource its management to the experts. This frees your time but usually comes with relatively high management fees. And we all know that fees erode the portfolio’s gain, right?

Finally, you could decide to open a passive stocks and shares ISA. There are three variants here:

  • Investing in index and mutual funds;
  • Investing with digital wealth managers using algorithms;
  • Investing in a fixed allocation portfolio.

My preference is for passive ISA investing – I don’t intent to make investing my life and experience has thought me that passive investing overall does better (mostly).

How to select an ISA (and provider)?

There are many things you need to decide upon to select the ISA that fits you perfectly.

  • First, you must decide whether you keep individual shares or basket investments in your ISA.
  • Next, you must decide on whether you want your ISA to be managed (self-managed or managed by a company) or passive.

These decisions already narrow down your selection of stocks and shares ISA and ISA providers.

There is an element of selecting an ISA, however, that we have not discussed yet – the selection rules that apply to decisions regarding any investment.

According to Tony Robbins (in his book Unshakable) there are four rules that ensure that our investments are sound without being overly conservative.

Risk awareness and potential loss

When you open, and contribute to, stocks and shares ISA (never mind the provider) you must be aware that it is extremely unlikely it will only make profits. There will be times when the value of your ISA (your investment) will go down.

This is likely to mirror the dips in the stock market discussed above (remember that corrections of up to 10% and ‘bear’ markets are a fact of an investor’s life).

Your ISA doesn’t have to behave so erratically. Whether it incurs losses at the top or bottom, of those experienced by the market, depends on the financial instruments it contains and the skill with which it is managed and re-balanced.

What you could do is to be aware that there is a risk and research the ISA provider well. It is also worth remembering that comparisons show managed funds rarely outperform index funds.

Profit awareness or potential return

Profit awareness when selecting an ISA is important but not that easy to judge. One thing you could do is look at the historical returns the provider has achieved. For an indication of past returns of some stocks and shares ISAs offered by digital wealth managers (for 2018 which was not a good year for stocks and shares) you check out this blog post.

Just to remind you that past performance, good or poor, is not guarantee for the future.

Tax/fee awareness

Taxes and fees can obliterate your earned interest; when compounded it gets rather frightening.

When you select the perfect investment ISA for you, make sure you understand all fees and taxes you’d incur.

Watch the fees. Some managed ISAs can come with steep fees; even digital wealth managers split their fees; e.g. providers charge their own fees, average investment fund costs and effects of market spread. (This is why, the fee for ISA with Nutmeg, for instance, is not 0.75% but it adds up to 1.01%. Call me petty now, if you wish, but as you build your investment portfolio, you’d come to agree with me that it adds up.)

Generally, Vanguard offer the lowest fees though this can vary depending on the index funds you select; followed shortly by other digital wealth managers.

Remember: fees compound and keeping fees low can make large difference to how profitable your ISA investment turns out to be.

Diversity awareness and how to diversify your ISA investment

Any investor, even a beginner, must know that diversification reduces risk (there are caveats, but we won’t get into these now).

When selecting the ISA that best suits you, ensure that it is diversified across:

  • Financial instruments. Your ISA investment is a portfolio of equities, bonds, real estate funds, commodities and cash. Usually the proportions depend on your risk tolerance and the characteristics of the market.
  • Industrial sectors. Holding stocks and shares of companies from one sector is risky.
  • Over a hundred of years data illustrates that the stock market rarely collapses everywhere at the same time. If you own only UK companies (or US companies) the value of your investment may drop like a stone off a cliff edge if the economy of the country tanks. When you own shares in companies from different countries your portfolio may lose value but it is highly likely the losses will be much lower because the effects of a sluggish economy in country A will be offset by economic growth in country B.

The perfect stocks and shares ISA formula:

Perfect Stocks and Shares ISA = (Relatively) low risk + high (potential) returns + low fees + high diversity

Important stocks and shares ISA rules you must know

I’m usually careful to learn the rules – it comes handy when I want to break them intelligently. I’ve been investing in a stocks and shares ISA for nearly a decade.

You’d think I know the rules of stocks and shares ISA like the back of my hand, right?

Not so, friend. My confidence evaporated when in 2018 we nearly gaffed big time because we didn’t realise you cannot invest in two ISAs of the same type in the same tax year. Go figure!

Research is my retreat; the fruits of researching the important, and mostly underplayed, rules of ISA are my gift to you.

These rules I’ve framed as questions.

Can you sell your stocks and shares ISA?

Yes, but…

Do you remember that a stocks and shares ISA is like the wrapping paper around a lovely piece of chocolate? You can wrap any kind of chocolate in it – index funds, ETFs, individual stocks and combination of these.

You can always sell the chocolate. Whether you should sell it is an entirely different matter.

Most people, sell their stocks and shares ISA when they:

  • need the money;
  • try to minimise their loss when the value of the ISA has declined.

You can’t do much if you need the money though dipping into your ISA is a very bad idea.

Selling because you fear loss, however, you must avoid at all cost. Remember that statistically downward stock market corrections recover in three to twelve months.

Yes, you can sell your stocks and shares ISA but you shouldn’t.

Can you withdraw your money from an investment ISA?

Yes, you can.

Because the investments you hold in your ISA must be sold, getting the money can take up to thirty days. Usually it take less than that.

What would happen to your stocks and shares ISA if/when you die?

Good question though I hope it won’t come to that anytime soon.

According to the old rules of stocks and shares ISA, in case of death your ISA would have lost its tax-free status. Your partner (or any beneficiary to your estate) would have had to start paying tax on any returns or income earned from the ISA.

This rule changed in April 2015.

According to the amended rules of investment ISAs, the tax-free benefits can be passed on by increasing the beneficiary’s tax-free allowance for the year of death to include the value of the inherited ISA.

For instance, if I die before March 2020, John’s ISA allowance for 2019-2020 would be:

£20,000 + value of Maria’s ISA

Rest assured that the tax benefits of ISA won’t be lost in case of death.

Can you have more than one stocks and shares ISA?

This question has a short answer and a longer one.

In brief, yes can have more than one stock and shares ISA.

Still, you must understand two things:

  • You can open one stocks and shares ISA, with a different provider, per tax year.
  • During a tax year you can contribute to only one stocks and shares ISA.

You can, however, split your ISA allowance between cash ISA, investment ISA and innovative finance ISA if it doesn’t exceed the yearly allowance (currently £20,000).

It doesn’t make much sense, I know. Still, splitting your yearly contribution between two stocks and shares ISAs may result in losing the tax benefit on one of them.

In brief: You can have more than one stocks and shares ISA and can contribute to only one during any given tax year.

Is your money safe in a stocks and shares ISA?

There are risks involved in every investment.

Your stocks and shares ISA is as risky as the investments you have in it.

(You can learn more about the risks that investing inevitably presents here.)

I’d also recommend you open an ISA with a provider covered by the Financial Services Compensation Scheme (FSCS).

How to calculate stocks and shares ISA fees?

Most people miscalculate the fees they pay for their stocks and shares ISA.

It took me some time to realise that providers charge three kinds of fees:

  • Fees for administering your account;
  • Investment fund costs; and
  • Market spread costs.

Doesn’t look much but it adds up. And it is always good to know how much you ISA investing costs you.

Can you have a joint stocks and shares ISA?

This is simple:

ISA is an individual account and you cannot open one in joint names or for someone else.

That’s it.

Can you open a stocks and shares ISA with poor credit score?

Yes, you can.

Some people believe that ISA providers refuse to open accounts on the grounds of poor credit score. This is not so – your credit score is important when you want to borrow money, not when you save money.

Who can open Stocks and Shares ISA?

Any UK resident over 18 years old can open, and contribute to, stocks and shares ISA.

What will happen to my Stocks and Shares ISA if I move abroad?

I you open a stocks and shares ISA and then move overseas you cannot contribute beyond the tax year when you moved. You should also tell your ISA provider that you are no longer a UK resident.

When does the financial year end?

In the UK, for personal finance purposes, the financial year starts on April 6 and ends on April 5.

This means that your deadline for contributing to your stocks and shares ISA for the current (personal) financial year is midnight on April 5th , 2020.

Finally…

It is time to put what you’ve learned about stocks and shares ISA into action.

You learned that stocks and shares ISA is a:

  • Tax-efficient wrap around various investments.
  • Good investment that can save you, as a beginner, much growing pain.
  • Investment vehicle that can befit you and your investment strategy.

You also learned:

  • How to select the best ISA for you (using the Perfect Stocks and Shares ISA formula); and
  • Rules of ISA that get ignored.

Research and compare some of the investment ISAs on offer, assess whether they match the future you envisage and start contributing. After that, all you need for investing success are patience, regular contributions and getting hold of your fear of loss.

Welcome to the wealth building side!