ISA season is looming large so it's time to recap on what exaactly an ISA is, what benefits they offer, how to take advantage of tax-free savings and investments, and how Morningstar.co.uk can help you research and select suitable investments to place in these tax efficient wrappers.
Holly Cook: Hi, I’m Holly Cook, online editor of Morningstar.co.uk, and I’m here today with Jackie Beard, Morningstar’s Director of Fund Research in the UK. Hi Jackie, thanks for joining me.
Jackie Beard: Hi Holly.
Cook: So, ISA season is looming large and if you want to take advantage of your full allowance for the current tax year, now is the time to do it. But first, can you tell us a little about ISAs, Jackie, what exactly are they?
Beard: An ISA is an individual savings account. These were set up by the government in 1999, the idea being to promote much more of a savings culture here in the UK. You can hold cash in an ISA or you can hold stocks and shares, but the key thing to remember is that it’s just a tax efficient wrapper, you still need to make choices about what you put in that wrapper.
Cook: “A tax-efficient wrapper” you say – what exactly does that mean?
Beard: Basically it means you are not going to pay tax. So if you have a cash ISA the interest is income tax free and if you make capital gains from an ISA you won’t pay Capital Gains Tax.
Cook: Tax-free savings? That sounds great! So can I put all my savings in an ISA?
Beard: Unfortunately not. The government is increasing the limit this year so from the 6th April that goes up to £10,200. You can choose to put that in two ways: You can have that cash ISA, which can go up to £5,100 but you could put the whole amount into an investment ISA, but the key proviso is that you only have one provider a year.
Cook: So I can build up a tax-free ISA portfolio over time by buying a new ISA each year. But you mention provider, how would I go about selecting the right one for me?
Beard: There are a couple of web sites you can look at, both the FSA and the HMRC will detail all ISA providers but it’s really down to personal choice. I tend to use a fund platform, I like the fact I can keep all my investments there together and it gives me freedom of choice as well because most investment houses have their funds listed there.
Cook: So, I’ve chosen my ISA provider, how can I then go about researching and selecting which investments to put in that tax-efficient wrapper?
Beard: At Morningstar, we’re strong advocates of funds because they give you very good diversification--you’re not putting all your eggs in one basket. That may work for the sophisticated investor who's going to pin all their hopes on the recovery of one bombed-out stock, but generally we think big funds are the way forward.
One way to do this would be to look at our ISA Quickrank and that will give you all funds that have ISA eligibility, which is about 4,000.
Cook: Over 4,000 funds--that’s a lot of research I’ve got to do. How can I narrow that down?
Beard: That’s a good question. There are two easy filters through our web site. The first is the Morningstar Star ratings--but this is very much a backward looking indicator, it’s very quantative and looks purely at risk-adjusted performance. So I’d encourage you to look at the Morningstar Qualitative Ratings. It’s much more forward thinking and really tries to tell you what the fund is going to do and how it behaves in the hope that you make the right choices for your funds.
Cook: Okay, so let's say that I’m just starting out in the world of investment and I’m going to use my ISA as a stand alone investment, what exactly would I want to look for?
Beard: If this is your first foray into investing then you would do well to look into a global fund--possibly to diversify away from the home bias you have about being in the UK. You could consider an asset split between equities and bonds, again to lower some risk. One really easy way to do this would be to use an ETF or a tracker. They’re very cheap, the only risk you are taking on is a market risk, and they’re diversified.
Cook: And how about if I’m using ISAs as part of a larger portfolio?
Beard: Well then you really need to see what it is you’re trying to achieve from those investments. You may want to take some income from the fund later on in life, then it would be good to build up that income because, don’t forget, the income will be tax free. You may want to put in those funds you think are going to offer you the highest capital gain over the long run because, again, capital gain is going to be tax free. But you must keep yourself in this long-term mind set, you want to look at least 3-5 years out, if not longer.
Cook: Thanks Jackie, that’s been really helpful.
Beard: Thank you, Holly
Cook: If viewers want to find out more about fund selection and asset allocation, there is a raft of information on our web site that can be found in the article archive, as well as investment tools such as Morningstar Instant X-Ray and Portfolio Manager. Both of which can be used to help with asset allocation and monitoring your portfolio over time.
I’m Holly Cook for Morningstar, thanks for watching.
