‘It is not a good time to talk about selecting the best ISA for me.’ – you may think. ‘The stock market is falling around our years, and my choice is clear – my spare cash stays in cash. Preferably in my savings bank account.’
In this, my friend, you are very wrong – exactly now is the time to talk about the best ISA for you because:
- ISA, the tax-free wrap around many traditional, alternative investments and cash, is still your best bet for a prosperous future.
- You don’t have to play around with stocks and shares to have an investment ISA – there are other options.
- Selecting the best ISA for you is easy, but you need to know what to look for.
Deciding which is the ISA for you is a bit like trying to decide which is the best precious stone in Aladdin’s cave – there is so much choice and competition, it is overwhelming.
Of course, you may decide to search the Internet for the best ISAs, but this comes with its issues – this search is far too broad, and you must know enough about the types of ISA to specify it. You may specify your search and look for the top returning fixed rate ISAs in 2020. Still, how do you decide between a return of 12% and a return of 2.1%?
Here is the thing: we are talking about your wealth, your savings, your investments. And your task is to select ‘the best ISA for you’.
These are the four key questions you must ask to be able to select the ISA investment for you.
What is the potential ISA loss?
When looking at the potential losses of an ISA account, you must pay attention to two kinds of loss:
- Potential losses because of the investments wrapped in your ISA; and
- Potential losses associated with trouble with the provider.
Let’s tackle the second one first. Companies can go bust, and ISA providers are not exempt. Hence, it is vital to make sure that your ISA provider is covered by the financial conduct authority (FCA). You can choose to open ISA accounts that are not covered by the FCA, but you will know you are taking a risk.
It is a bit more complicated when it comes to working out the potential losses because of the investments, or savings, you’ve wrapped in an ISA. Here is what to expect as a level of potential (apparent) level of loss with different types of ISA:
|Cash ISA||Stocks and Shares ISA||Innovative Finance ISA|
|Low||Medium to High||High|
A word of caution:
- As a rule, cash ISAs come with a, what appears to be, low level of loss. Still, depending on their levels of return and the level of inflation, you may find that you are losing money faster than water goes through a sieve.
- Stocks and shares ISAs can be vastly different according to the potential loss they carry, depending on whether these are individual shares, ETFs, index funds, or bonds.
- Innovative finance ISAs, usually offered by P-2-P landers and business adventurers (like investing in prospecting for gold in Africa), come with a high potential level of risk because they are mostly not FCA covered.
Analyse ISAs with these risks in mind. To select the appropriate ISA for you, you must also ask yourself what your level of risk tolerance is – never choose an ISA with a potential loss that is far above your personal loss tolerance level. You will end up getting out of it when you shouldn’t, like right now.
(A good thing to remember is that a drop of the stock market of up to 10% happens several times a year and recovers within weeks; a decline of 40% or over occurs every five years or so and recovers within eighteen months.)
What are the ISA fees?
Usually, I’d say you must watch the tax and fees, but ISAs are tax-free so…Let’s focus on costs.
Generally, the lower the fee, the better for you. When you are working out how much is the ISA fee, look for the things that are not immediately obvious – most providers split the charge between management fee, trading fee, and the cost of the spread.
A small increase in fees can affect your investments rather severely in the long run.
What is the potential gain of the ISA account?
To work this out, you’d best check out the potential returns that the ISA providers have achieved historically. Most ISA providers are open, even vocal, about their past performance.
And remember, past performance is not a guarantee for future returns, and there is always a risk.
Is the ISA appropriately diversified?
How can diversification be ‘improper’? – you may ask.
Lately, it can. You may find that many ISAs that appear diversified on the surface are very uniform. It is because they use the same ETFs, Index funds, etc.
It is always worth ensuring that your ISA portfolio is diversified.
For instance, you may find little difference between two stocks and shares ISA providers because their accounts use the same Vanguard funds.
There is a trick to diversifying your ISA portfolio – contribute to different types of ISAs (the rules allow you to contribute to one cash, one stocks and shares, and one Innovative Finance ISA within a tax year).
The ‘Best ISA for You’ formula:
Best ISA for me = Acceptable risk level + low fees + high (potential) returns + high diversification
To select the best ISA for you, ensure that you:
- are aware of your loss tolerance;
- have researched the potential loss of the ISA;
- are versed with all ISA fees;
- have information on historical returns; and
- have enough knowledge to diversify your ISA portfolio appropriately.
You already know the ‘Best ISA for You’ formula. Go and research ISAs.
You have until the beginning of April to use your tax-free contribution of £20,000 this tax year. Go get it!