THE Individual Savings Account (ISA) is the most popular tax- efficient way to build up an investment. With so many shares depressed in price, this could be the best time to pick up a bargain since ISAs were launched in April 1999.
An ISA is free of both UK income and capital gains tax, except for the 10 per cent tax credit on dividends from UK companies which the Treasury withholds. This year, up to 7,200 can be invested in an ISA, up 200.
The whole amount can be invested in equities or split – up to half in cash and the balance in stocks and shares. Remember that the ISA allowance is for one year at a time and, if not fully used, cannot be claimed for past years. Incidentally, the former Personal Equity Plan (PEP) has now been renamed as the ISA.
An ISA has no minimum holding period, unlike other tax-efficient vehicles like Venture Capital Trusts. However, to gain most benefit, think of it as a long-term investment.
With some indices down more than 20 per cent, this could prove an astute time to go for a regular savings plan. Jason Hollands, of fund provider F&C, suggests monthly contributions to an ISA could be an ideal way, in the long term, to ensure a lower average price per unit than a one-off lump sum.
This is certainly not the time to sit on the sidelines. Yet UK households are saving at their lowest rate for half a century. Money invested in savings accounts and pensions has dropped to 1.1 per cent of household income, which is the lowest since 1959. In the 1980s, the ratio averaged 8 per cent. By way of comparison, Japan's savings ratio is 28.6 per cent.
"Most definitely look for funds with specific diversification, perhaps those who have been actively buying into financials and builders," tips Alex MacLean of Edinburgh-based advisers, Aspire Wealth Management. MacLean says these two sectors may not be flavour of the month, but "the reality is that these sectors will recover as there is a significant shortfall in UK housing with the banking sector an integral part of economies worldwide."
Paul Galloway, of Edinburgh Risk Management, says that two of the most popular areas are the fixed-interest and money market sectors. He favours the SWIP Absolute Return Bond as fitting this bill, but also likes the Henderson Strategic Bond Fund, which can invest in any fixed income, thereby offering different levels of risk and return.
While not currently favouring UK stocks exposed to the domestic economy, Paul picks out the Aegon UK Equity Fund for its large-cap bias where the stocks have international earnings.
In choosing an appropriate fund, ask your adviser about access to the widest choice – placing on a so-called "supermarket platform" – which enables a switch between funds to be economical while retaining ISA status.
Given current market conditions, Kate Philip, of financial advisers Independent Women, prefers large-cap funds "as they tend to be more robust in difficult economic conditions." Philip also favours global funds as this lets the manager roam without restriction to seek the best returns.
Rathbone Global Opportunities and Neptune Global Equity are favourites. Over three years, the funds have soared 40.1 and 62.7 per cent respectively. However, avoid bank-backed ISAs, says Philip, "as they tend to only offer investment in the bank's own funds and are therefore too restrictive."
There is a strong case for a "fund of funds" during periods like this, particularly the T Bailey Growth and Jupiter Merlyn, according to MacLean. He says neither is significantly restricted by geography or theme which "could prove a major benefit as and when we move into more stable economic conditions."
Definitely clear out under- performing funds. These include Newton's Higher Income and many in-house funds run by life offices, such as Prudential's UK Growth and International Growth.
In the UK smaller companies sector, over three years, AXA Framlington (-12.5 per cent), HSBC (-13.9 per cent) and Invesco Perpetual (-16.4 per cent) should be avoided. Among Japanese funds, switch out of BlackRock (-22 per cent), Legg Mason (-67 per cent), Newton (-26.6 per cent) and Threadneedle (-22.6 per cent), all poorly performing over the period.
Now could be the time to switch to the US. America's economy led the global downturn and, says Galloway, "there are signs that the weak dollar is starting to aid US exporters, while even the domestic economy seems to have found a depressed level of support." A fund to give exposure to this equity market would be Martin Currie North America, which is up 21.9 per cent over three years, compared with 4.21 per cent for the sector.
Investor concerns about the US are overblown, with its economy likely to rebound next year, predicts Jenny Jones, manager of Schroder US Small & Mid Cap Fund.
Nearer home, continental Europe has some bright stars. Over three years, Baring European Growth (up 38.7 per cent), JP Morgan Europe Dynamic (up 44 per cent), Neptune European Opportunities (up 57 per cent) and Standard Life European Equity (up 37.9 per cent) are the leaders.
Rob Burnett of Neptune says that the Russian economy is among the least exposed to the impact of the credit crunch and remains very stable politically in spite of geopolitical concerns on its borders.
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