A beginner’s guide to stocks and shares ISAs

Dipping your toe into the stock market for the first time can be daunting, so do plenty of research before taking the plunge.

Before the end of this tax year, on April 5, 2013, you can save your full ISA allowance of £11,280 tax-free in stocks and shares – and a further £11,520 from next tax year, starting on April 6.

But where will your money go if you opt for this route? Read our beginner’s guide to stocks and shares ISAs to find out…

Where is my money invested?

First, a word of warning. With a stocks and shares ISA, your money is invested in the shares of individual companies, and the value of these can rise and fall - so you risk getting back less than you paid in.

Most people choose to hold pooled investments within the ISA wrapper to spread risk, which include unit trusts, open-ended investment companies (OEICs) and investment trusts.

A fund manager is responsible for picking which shares to hold in these investments, and will usually focus on a particular sector or geographical area. As your money is invested in a wide range of different shares, the risks are lower than if you invest in just one or two.

You can hold individual shares in what is known as a ‘self-select’ ISA, but bear in mind the fewer companies you invest in, the greater the risk involved.

If, over time, your ISA funds aren’t performing as well as you’d hoped, you can switch to a different provider. However, while you can also transfer from a cash ISA to a stocks and shares ISA, you can’t do the reverse.

Who are stocks and shares ISAs suitable for?

If you are prepared to accept a level of risk in return for potentially higher rewards than gained from investing in cash, then stocks and shares may be worth considering.

However, they are not for the faint-hearted given the possibility that they’ll slump in value. That means they won’t be suitable for anyone who needs to be absolutely certain that they will get what they invest back - for example, if they are saving for a deposit on a property.

You must be aged at least 18 to open a stocks and shares ISA, whereas you only have to be 16 to open a cash ISA.

What investment term should I be looking at?

Stocks and shares ISAs should be held for a minimum of five to 10 years. Although you can usually access your funds whenever you want to, investing for the long term means that you will have a much better chance of riding out any stock market volatility.

Are there tax advantages?

You won't pay tax on any increase in the value of your investment or on any withdrawals, as ISAs are free from both income tax and capital gains tax (CGT).

There are other tax advantages for higher rate taxpayers too. For example, if you earn dividends from investments held outside of an ISA, you will pay normally tax of 32.50% if you're a higher rate taxpayer and 42.50% if you're an additional rate taxpayer - although 10% of this is automatically deducted before you receive the dividends.

If you're investing within an ISA, however, you will only pay 10% tax on the dividends. If you’re a basic rate taxpayer dividends receive the same tax treatment regardless of whether they’re in an ISA or not.

Are there ways to reduce volatility?

Many people choose to invest in stocks and shares ISAs monthly rather than making big lump sum payments, as this can help smooth out stock market volatility. This is because you buy fewer shares when prices are high and more when prices are low. You also don’t have to worry about deciding when the best time to invest is. Most fund managers allow you to invest from £25 or £50 a month, so stocks and shares ISAs aren’t only for the super-rich.

Other ways to reduce volatility include picking investments which cover a wide range of geographical areas and sectors. That way, if any of these don’t perform well, your losses will be limited. You should therefore try to diversify your investments between the four main asset classes – cash, fixed interest securities, property and equities – to help reduce the overall level of risk.

If you’re not sure where to start, begin with investment areas you are familiar with, such as the UK. One option might be to go for a tracker fund, which as the name suggests, follows a particular stock market index, such as the FTSE 100 Index of Britain’s biggest companies.

What charges should I look out for?

Many unit trusts and open-ended investment companies have initial fees of around 5%, with further annual management fees of 1-1.5%.

However, there are plenty of ways you can keep these charges to a minimum. For example, fund supermarkets can “bulk-buy” funds, giving big discounts on initial charges.  As their name suggests, these allow investors to effectively ‘shop’ online for funds from several different managers.

Another advantage of investing via a fund supermarket is that you have 24-hour access to your investments, so that you can monitor your portfolio’s performance at any time of the day or night, and can make changes whenever you want to.

Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.

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