Luisa Rollenhagen is a journalist and investor who writes about financial planning for Wealthsimple. She is a past winner of the David James Burrell Prize for journalistic achievement and her work has been published in GQ Magazine and BuzzFeed. Luisa earned her M.A. in Journalism at New York University and is now based in Berlin, Germany.
What is a stocks and shares ISA
ISA stands for Individual Savings Account,” and while there are two kinds, cash ISAs and stocks and shares ISAs, we’re going to focus on the latter one. Why? Because when it comes to long-term saving and reaping the (tax-free!) benefits of investing, the stocks and shares ISA is where it’s at.
While a cash ISA is a safe spot where you can park money like an emergency fund, generally the low-interest rates on cash ISAs might be holding you back if you're saving for the long term. With a stocks and shares ISA, you keep your money in equities which in the past have generated higher returns (FTSE All Shares Index) than savings interest you gain from a cash ISAs.
So why doesn’t everyone keep all of their money in ISAs if the returns are tax-free? Well, because in order to avoid everyone skipping out on taxes entirely, the government has placed an allowance, or limit, on how much you can put into your ISA in a (tax) year. The stocks and shares ISA limit for the tax year 2018/2019 is £20,000, which means that you can invest up to £20,000 during that period, either as a lump sum or in bits and pieces throughout the year. It’s also important to remember that any unused allowance for that tax year doesn't roll over into the next year. You can learn more about ISA allowances and rules here.
Choosing your ISA portfolio
A stocks and shares ISA gives you a lot of freedom because what you put in is entirely up to you. You can choose from stocks, bonds, or managed funds. It's worthwhile building a diversified portfolio of ETFs (exchange-traded funds). An ETF essentially allows you to own a sliver of many stocks and bonds. This helps you to diversify your investments rather than zero in on a single stock. It's beneficial as if one particular investment takes a hit your entire investment portfolio is not dragged down.
You don't need the knowledge of Warren Buffet to start investing in an ISA. There are many companies that will invest your money for you — while you stick the kettle on! This is referred to as automated investing. You simply take a quick risk survey and a personalised portfolio is generated to suit your exact needs. You can even control what goes into your ISA. If you're inclined to invest in a socially responsible way, that's very possible.
How does a stocks and shares ISA work?
You can either set up a stocks and shares ISA yourself through an online investment platform or you can go through an advisor. Ideally, you should try and choose a provider that will _work with you to choose a balanced, diversified investment portfolio that reflects your personal financial goals and your risk tolerance. In addition to shares of companies on the stock market, you can also invest in:
Open Ended Investment Companies (OEICs)
But for those who don’t have the time or patience to painstakingly follow the daily minutiae fluctuations of individual stocks and research companies and financial forecasts to see where you should be investing your money, a balanced portfolio of ETFs that contain a mix of stocks and bonds is an unsexy but pretty reliable way to ensure you’re diversifying your investments.
By having your investments in a stocks and shares ISA, you're also maximising your opportunity for returns thanks to the taxed advantage nature of the account. That’s because any gains you make will be free from capital gains tax (CGT), tax on dividends, and income tax. The longer you can invest your money for — the more you stand to make thanks to the miracle of compound interest.
It's important to note that while there are a number of advantages to a stocks and shares ISA, there are some risks to be aware of too. While you stand to make money, you could also lose some — that's investing. The same as any other account Stocks and Shares ISAs generally come with fees but they are not any higher than any other investment account for the most part. The trick is to keep them as low — high fees will eat into any investment gains you make. Fees on ISAs usually consist of maintenance charges (depending on the platform), brokers fees, and starting fees. Look out for a provider with no account minimum, low fees and if possible some access to investment advice should you need it.
What is a Junior Stocks and Shares ISA
Just like the grown-up version, a junior individual savings account (JISA) lets investment gains and income grow tax-free, something your kid probably can’t appreciate right now but will in the future. It’s available to children under the age of 18 who live in the UK, and are set up by the child’s parent or legal guardian (unless the child is 16 or over, and then they can do it themselves).
If you contribute regularly to a JISA (and teach your kid how to contribute and build up healthy saving habits too), your kid will be off to a really good start before they’ve even started university.
Stocks & Shares ISA returns
At the end of the day, a stocks and shares ISA is an investment portfolio. That means that your money is subject to the same risks as it is with any other investment, it could increase or decrease in value. But the appealing thing about the stocks and shares ISA (as opposed to a cash ISA) is the potential for higher returns. This is because recently the average annual returns on savings in the UK has been between 1% and 2%, while the return of investments on the FTSE Index has been about 7% per year on average. So you could say you're taking a higher risk in order to potentially gain a higher return.
Although you can pay into your ISA in a lump sum or in regular intervals, it’s usually more sustainable to deposit a certain manageable amount each month. Many ISAs allow you to set up direct deposits, so you can literally just set it and forget it. Well, not really forget it, because if you do this you have to make sure you don’t go over your annual £20,000 allowance. But steady, long-term contributions take the stress out of investing and will isolate you more from the ups and downs of the market. This is because, although the markets rise and fall, in the past, over longer periods of time, they have risen (FTSE Index) into their long-term average prices.
If returns are what you're after, one thing that's going to help is time. If you can afford to live without your savings for at least five to ten years you'll benefit greatly from the power of compound interest.
Stocks & Shares ISA rules
As mentioned before, you have a £20,000 annual limit that you can contribute to your ISA. Also, any unused allowance for that tax year (which always starts April 6 and ends on April 5 of the next year) doesn't roll over into the next year. So if you only contributed £16,000 to your ISA for 2018/19, you won’t get a £24,000 allowance next year. It just goes back to £20,000.
If you do happen to over-contribute, then the first thing you need to do is report it to HM Revenue and Customs (or they'll reach out to you, depending on how soon you notice your mistake). All investments in the ISA that were made after the limit was passed will no longer be eligible for tax exemption and will be returned. In addition, any interest earned on the excess money will be taxed.
Can I have more than one stocks and shares ISA? You can have more than one ISA. However, you can only pay into one of them each tax year. So once you paid into one, you need to leave any other ones alone for that year. But you can open a new ISA with a different provider each year if you want to.
Can I have a cash ISA and a stocks and shares ISA? Yes, you can have both a cash ISA and a stocks and shares ISA. You can open both types of ISAs in the same year (but only one of each). However, the total amount you put in annually cannot exceed £20,000, regardless of how it’s split between the two.
How to withdraw money from Stocks & Shares ISA
You can take money out of your stocks and shares ISA at any time. What’s important to remember though is that you if you reinvest that money during the same tax year that you’ve withdrawn it, it will count toward your annual allowance. Also, depending on what kind of account you have, your withdrawal might not count against your current year’s allowance. These are known as “flexible ISAs” (your ISA provider will be able to tell you whether yours is flexible or not).
So let’s say your allowance is £20,000 and you have £10,000 in a stocks and shares ISA and take out £3,000. The amount you can now put in during the same tax year is £13,000 if your ISA is flexible (the remaining allowance of £10,000 plus the £3,000 you took out), and £10,000 if your ISA is not flexible (just the remaining allowance).
How to transfer a cash ISA to a Stocks and Shares ISA
If you’ve been holding your money in a cash ISA but are sick of the low return rates and want to really put your money to work in the long term with a stocks and shares ISA, the good news is that you can easily switch. However, you can’t switch from a stocks and shares to a cash ISA. To switch accounts, contact the ISA provider you want to move to and fill out an ISA transfer form to move your account.
In the market for an ISA? Give Wealthsimple a holler. With a Wealthsimple Stocks and Shares ISA, you’ll be set up with a low-fee, diversified portfolio tailored to your financial goals, with expert advice guiding you at every step of the way. It’s all the good parts of smart investing, just with minimal stress. Get started with a Wealthsimple ISA and see what we're talking about for yourself.