Teresa Hunter: Is Isa tax break worth the risk?

Published on 22/03/2008 13:11

ANYONE hoping to cash in on this year's tax-free equity Isa allowance will have watched last week's stock market dramas with horror. Wall Street crashed along with Bear Stearns amid fears of more to come, only to rally when the next set of banking results were better than feared.

In the UK, rogue traders set out to bring HBOS to its knees by spreading lies about its financial strength and liquidity.

Unsurprisingly, Isa sales so far this year are running at barely half last year's levels.

Yet advisers are warning that it can be folly for long-term savers to allow this year's 7,000 maxi Isa limit to pass unused, as it can be a valuable tax-break, particularly for those planning for retirement. Once lost it is gone forever.

Graeme Lind, wealth adviser at Towry Law in Edinburgh, argues: "Making the most of your tax break should be part of your overall financial planning strategy, regardless of what is happening to the markets.

"You should see your Isa allowance as a way of adjusting overall exposure to different markets. If you are top heavy in equities, then add some fixed interest."

Alan Steel, of Alan Steel Asset Management in Linlithgow, adds: "I just can't understand why anyone with cash to invest would pass up the chance of this tax break.

"And often investor logic for staying out makes no sense at all. They won't buy because the market has fallen. Does that mean they would be much happier if they had to pay considerably more for their investments than they do right now? They will buy with the FTSE at 6500 but not at 5600."

That doesn't mean that buying now is without risk, as most observers expect shares to fall further before they recover. Investors have to weigh up the loss of the tax shelter against the threat that their investment could fall further in the short term.

During the last tax year investors ploughed 2.4bn of new money into equity Isas, but this year's figures to January barely pass 1bn.

February's figures due this week from the Investment Management Association are unlikely to bring much joy. Rather than new money, the past three months have seen a net outflow from investment funds.

One sector holding up is cautious managed or defensive funds, bringing in more than 390m in net new investment.

Cautious funds all have their own approach, but in general they have a spread of holdings including commercial property and fixed interest as well as equities.

So while the FTSE 100 has melted by around 14% over six months, defensive funds have fallen by only 3% or 4%. Over a month the FTSE 100 is down 7% while the cautious managed funds have remained stable, trimming by only 1% or so.

Gary Shaughnessy, managing director of Prudential Retail Life & Pensions, says: "We are seeing people adopt a more prudent approach to investing. Yet, while caution is the name of the game, these funds aim to deliver long-term growth which can be particularly important for those who are planning for retirement."

But not everyone is convinced. Steel says: "My objection is that they don't always do what they say. Some aren't particularly cautious because they can have more than 60% in equities, while others aren't particularly defensive, because they can fall along with everything else."

Lind agrees: "In our view it is unlikely the person managing the portfolio will be best at both equities and fixed interest. We prefer to put clients into what we know are well run equity and fixed interest funds, if that is where they ought to be."

Yet over the longer-term the funds have performed reasonably respectably. Over five years the FTSE 100 has climbed around 45%. Not many of the more than 100 cautious managed funds were around five years ago but of those that were, City Financial has produced value increases of 162.22%, Cazenove Diversity 86% growth and Swip Diversified 84%.

Stewart Siegel, a principal at Punter Southall, believes some of the cautious managed funds have performed respectably, but says investors should not be afraid of taking risks with their Isa allowance. Rather he believes the tax wrapper should be the place where serious investors take their biggest risk:

"It makes sense to take the highest degree of risk in the hope of a superior return within the Isa because if it does well the gain will not be taxed."

Data from Fidelity Funds Network confirms cautious managed funds are the biggest seller, along with global growth, although income funds are also very popular because their income stream can still provide value in volatile markets.

Fiona's cautious to avoid being stung

FIONA McDade is a firm believer in making the most of her annual Isa allowance, but doesn't want to be stung if the market falls further before recovering. So she researched her options carefully and has decided on a defensive managed fund.

The Dundee software product manager said: "It seems like almost nothing in life is tax-free, so it makes sense to me to make the most of any tax break which is on offer. But obviously markets are uncertain, so you have to be careful. That said, I'm not too worried about what happens over the next couple of years, as I have a 10-year investment horizon."

Fiona, 38, has been saving via Isas since they were first introduced in 1999, initially limiting her investments to cash Isas only. More recently, she has spread her wings into investment funds and shares. She said: "I had built up quite a bit of cash and became worried about being unbalanced, so started to look at equity Isas. First I bought into Fidelity's Special Situations, and did quite well from that. Then I decided to try doing it myself via self-select Isas. I had great fun and really enjoyed it, but I got really stung."

This encouraged her to look for a safer option when she came across defensive funds. "This fund has bonds and property so will give me much greater diversification, as my other funds are all invested in the FTSE 100. I learnt from the self-select Isa that markets can be risky and you have to be careful."