A stocks and shares ISA is a type of investment account, as opposed to a traditional savings account, that can be an efficient way of helping your money grow over the long term.
Whilst a savings account provides risk-free returns, a stocks and shares ISA involves investing in the stock market, which could enable you to garner significant gains from your investment if you plan to invest for the long term.
Nevertheless, this type of investment doesn’t come without its risks: the unpredictable nature of the stock market means you could potentially lose money on your original investment.
It’s therefore important to keep in mind that there are no certainties when it comes to the stock market and that investing in a stocks and shares ISA should be based on your long-term savings goals to avoid financial difficulties.
How does a stocks and shares ISA work?
A stocks and shares ISA would prove most beneficial if you are prepared to invest your money over long-term periods – at least 5 to 10 years. Whilst stocks and shares prices tend to increase over time, the market is volatile and means they can go up as well as down. If you invest your money for a longer period, however, your returns are more likely to recover from any drops in the market.
With a stocks and shares ISA, your money is also likely to grow further at a faster rate, as all the profits you earn from it are tax free. This means that you aren’t subject to income or Capital Gains Tax on any returns you make on your investments.
When opening this type of ISA, you can either pay a fund manager to manage your investments or decide where to invest your money yourself – the choice you make will likely be based on how experienced you are with stocks and shares.
Utilise your ISA allowance
Each year, you are eligible for a set ISA allowance – otherwise known as the maximum amount you can put into an ISA without paying tax on anything it earns. The ISA allowance for the current 2021/22 tax year is £20,000 per person.
The £20,000 annual allowance is a combined limit across all ISAs you may have. The two main types of ISA are a cash ISA, and a stocks and shares ISA. You can only save into one of each type of ISA per year.
Depending on your individual circumstances – and your appetite for risk – you could choose to invest all of your allowance into a stocks and shares ISA, or you could choose to split it between both types.
There are potential risks when it comes to investing in a stocks and shares ISA due to the unpredictability of the stock market. If you put your total ISA allowance into a stocks and shares ISA and the stock market falls, it’s possible that you wouldn’t get any returns and may therefore lose money on your original investment. In this instance, you wouldn’t be able to make any further investment in the same tax year.
Similarly, it is important to note that inflation can erode the value of a cash ISA, meaning a cash ISA is also not free of risk.
People can often have a ‘do not spend’ attitude when it comes to their ISA accounts, leaving the whole amount in cash, and consequently earning very low returns. For that reason, investing your ISA allowance across both types of ISA may be a sensible approach to maximising returns, and managing overall risk. It is possible to transfer money from a cash ISA to a stocks and shares ISA, and in some cases it is possible to trasfer money from a stock and shares ISA to a cash ISA.
Don’t wait until the end of the tax year to use your ISA allowance
Investing, particularly when it comes to stocks and shares, requires long-term planning. As such, the earlier in the tax year you put your money into an ISA, the more chance you have of making stronger gains over time.
Many people wait until the end of the tax year (5 April) to use their allowances, but the earlier you can start putting money into an ISA the better, as this will allow your money to benefit from compounding.
In investment terms, compounding is where the money you make through investment is then reinvested, allowing any monetary gains to build upon themselves, thus helping you to earn more long-term.
To benefit from compounding, you should avoid waiting until the end of the tax year to use your allowance. If you don’t have all the funds available to use your total allowance now, it would still be beneficial to start investing as soon as you can, regardless of the amount you are able to put into your ISA.
In doing so, the money you invest now will still have the benefit of compounding over the course of the year and, if you have further funds available closer to the end of the tax year, these can then be invested at a later date. For this reason, regularly investing small amounts of money with a long-term aim can be a lucrative way of saving.
How we can help
Whilst you could potentially get a better return from a stocks and shares ISA compared to a cash ISA or traditional savings account, this type of investment is not without risk.
If you are considering investing in a stocks and shares ISA as part of your long-term savings goals, we would recommend speaking to an Independent Financial Adviser in the first instance. We can help by understanding the potential outcomes of your investment, based on your individual circumstance and long-term goals.
Regardless of the approach you take, saving or investing on a regular basis is a good habit to get in to at an early stage. If you would like to arrange an initial discussion about your long-term savings goals, and the best investment products to meet them, please do not hesitate to get in touch.
Important information – please keep in mind that the value of investments can go down as well as up, so you may get back less than you invest. Tax treatment depends on individual circumstances and all tax rules may change in the future. This information is not a personal recommendation for this particular investment. If you are unsure about the suitability of an ISA investment you should speak to an authorised financial adviser.