An International Savings Account? An Imaginative Swindling Act? An Incredibly Serendipitous Acquisition? What is an ISA, anyway?
Many Morningstar readers, especially those who frequent our ISA page, would be able to answer right away that ISA stands for an Individual Savings Account. However, with these tax-efficient wrappers the name does not say it all.
The specifics of investment within an ISA can give rise to multiple questions and misconceptions, which can take their toll on the potential benefits of the tax-efficient scheme. Thus, every day during our 2011 ISA Week we will be lifting the veil on some of the common sources of confusion and investor delusion by addressing ISA-related misconceptions.
1. Individual Savings Accounts are only for cash and must be purchased from your current bank
Investors are encouraged to shop around for the best ISA scheme. With interest rates currently at historic lows, ISAs offering interest rates for savers of much more than 3% are few and far between so it’s worth shopping around for the best deal—it may not necessarily be that offered by your bank. Though the maximum you can save and invest in an ISA in the current 2010/2011 tax year is £10,200, only half of this can be saved in cash. The remainder—or the entire annual allowance can be allocated to a combination of the following:
-- Shares and corporate bonds issued by companies officially listed on a recognised stock exchange anywhere in the world;
-- Bonds issued by the UK government or other countries in the European Economic Area
-- Units or shares in OEICs or closed-end funds;
-- Life insurance policies.
2. I don’t like ISAs, they don’t perform
It is possible that past experience of investing in an ISA has yielded disappointing results but there is no reason to extrapolate the discontent with the past to the entire concept of investing in an ISA-eligible vehicle. The ISA is just the wrapper that enables you to invest tax-efficiently. What perform are the investments you place within that wrapper.
Selection of ISA investments is subject to all the scrutiny and investment logic that goes into regular portfolio planning, with the exception that not all funds are available to be placed in an ISA.
There are a number of ways to check which fund providers offer ISA-eligible vehicles. The full list of ISA-approved managers is available on this government website and Morningstar’s fund reports also display their ISA eligibility under the Fees section. You can rank ISA-eligible OEICs using Morningstar’s ISA Quickrank tool.
3. ISAs are risky
Similar to the point made above, the risk/reward profile of an ISA investment is related to the particular companies, governments or funds that one has invested in. Investing through a government-sponsored tax-efficient scheme is not a tool to hedge or increase risk exposure or impact on returns. That said, AIM-listed equities cannot be held in an ISA due to their risk profile and relative lack of liquidity.
Cash ISAs, of course, have a return rate set at the offered interest rate and are insulated from the peril of bank default via the government-backed Financial Services Compensation Scheme, which covers up to £85,000 of cash deposits.
