Get ready to hear a lot more about individual savings accounts (ISAs).
Your yearly allowance (we’ll go into what that is in a sec) runs until early April so you’ll probably see big posters everywhere, guiding you politely towards using yours.
Well, you would if we were using train stations and buses like we used to.
That means now seems like a good time to get to grips with what these ISA things are and how you can use them.
What is an ISA?
An ISA is an account you can use to put money away and, with a stocks and shares ISA, invest it for your future.
There are important tax benefits included, as well as flexibility in putting money in and taking it out when you need it.
A key thing to understand from the get-go is that the ISA is just the outer shell for you to fill with your investments - it’s not an investment itself.
That’s why you’ll often hear it described as a ‘wrapper’ - you get to decide on the filling.
And the reason you’ll also hear that one-upped to ‘tax wrapper’ is because, when you put your investments in an ISA, you don’t have to pay tax on any growth your investments achieve.
That’s possible because the most common way to add money to your ISA is from your post-tax pay.
So that money has already been taxed, unlike pension savings which skip tax on the way in and only get taxed on the way out.
How much can I invest in an ISA?
That tax benefit is also possible because there is a limit to how much you can put in your ISA each tax year.
This contribution limit is set at £20,000 for 2021/22 (from April to April). Keep an eye out though as these allowances can change each year.
The other thing to remember is that there are a million flavours of ISA.
Well, not quite that many but a few examples are Lifetime ISAs (geared towards saving for a house or retirement), cash ISAs mainly offered by banks and building societies, and the most common for investors - the stocks and shares ISA.
Whether you choose one of these, a few of them or even some of the more exotic ones like an Innovative Finance ISA, bear in mind that your combined contributions into all of them can’t go above that £20,000 in a single tax year.
You should also remember that you can’t roll over your allowance. So if you only use half of it in one year, you can’t keep the remaining half for the following one.
You can also only open one stocks and shares ISA with one provider each year.
If you find another company whose fees are lower, or whose platform just suits you better, you can either transfer your current ISA to them, or wait until the new tax year to open a brand new ISA with them.
When should I start investing in an ISA?
This brings us back to the ISA just being the outer shell again. Once it comes to deciding when or why you should start actually investing (in an ISA or not) it becomes a very personal choice.
If you aren’t sure, have a look at our investment principles to see if you’re ready.
But if you’re all set and just umming and ah-ing about when the best time is to start, remember investing is all about giving your money enough time to build up that snowball effect of compound interest.
Time is such an important part of investing - the longer you give your money to grow, the better.
And while there are no guarantees on individual investment performance, when you take a step back and look at the history of stock markets, the trend goes towards the top right of the page.
As a simple illustration of compounding, imagine you put £10,000 into your ISA and choose your own investments.
If those investments grew by 5% in the first year (a not unreasonable goal) you’d have £10,500.
In the second year your initial £10,000 is still able to generate returns or losses, but now that extra £500 is too.
If you achieve 5% growth by the end of your second year your new total would be £11,025 thanks to your growth generating its own growth. That’s the beauty of compounding.
Assuming this 5% growth continues (again, just an illustration) your initial £10,000 could become over £16,000 by the tenth year, and over £26,000 by year 20.
Of course, it would be a bit weird to generate exactly the same returns each year, and it’s worth highlighting that the stock market really can go down as well as up.
But the point remains that time and compounding are forces that work best the earlier you start.
As an old colleague always told me, “The best time to start investing was 50 years ago. The second best time is today.”
How you can become an ISA millionaire (the realistic view)
The Freetrade ISA
We got into the brokerage business to make investing simple and affordable and, ultimately, to get everyone investing. We don’t charge platform fees and we don’t charge trading commissions.
Instead, for the ISA you pay a flat monthly fee of £3.
Once you’re set up you’re free to invest with the peace of mind that commissions aren’t going to be eroding your investment returns over the long term.
What’s the best way to use my ISA?
When it comes to how to factor your ISA into the rest of your savings, it starts to depend very much on your personal circumstances, what your goals are and when you’ll actually need the money.
I’ll be writing a lot more on some of my favourite ISA strategies as we come into the new year but this is where it would be great to hear from you on what you want to know.
If you have any general questions on how best to use your ISA now and in the new tax year, get in touch.
I won’t be able to touch on anything too personal (I’m not a financial adviser) but if you have a query, chances are a lot of other investors do too.
My plan is to not just throw out generic textbook info on ISAs, but really equip our community with enough ISA knowledge to feel confident and make good investing a bit easier.
More resources to help you make better investment decisions:
This should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.
When you invest, your capital is at risk. The value of your portfolio can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future results.
Freetrade is a trading name of Freetrade Limited, which is a member firm of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales (no. 09797821).