Investment: Risk proves rewarding as Isa savers find cash doesn't pay

STOCKS and shares are expected to dominate this year's Isa season as savers try to counter rising inflation.

Savers and investors have until midnight on 5 April to use up this year's 10,200 tax-free individual savings account (Isa) allowance, up to 5,100 of which can be saved in a cash Isa. Next year's allowance of 10,680 (5,340 in cash) can be used from 6 April.

But with interest rates marooned at 0.5 per cent since March 2009 and set to remain low for months to come, many of those who previously would have stuck with cash are favouring riskier options.

Competition in the cash Isa market has intensified in recent weeks, but inflation - which hit 4.4 per cent in February, it was revealed yesterday - means there is now just a handful of fixed-rate Isas that protect savings against rising prices.

The latest inflation report is expected to drive more people into stock market investments. Two-thirds of consumers have never considered opening a stocks and shares Isa, according to Fidelity, but 86 per cent of those are now reviewing their stance as they seek an alternative to cash.

Graeme Forbes, chartered financial planner at Intelligent Capital in Glasgow, said: "Stocks and shares Isas needn't be off the risk scale - there are plenty of investment funds and strategies to cater for lower-risk investors.

"Not only should this year's Isa not be lost, but think about money you currently have in cash Isas that is earning very little - either find a good cash Isa rate or consider some investment options for a little more investment risk."

Forbes expects the UK equity income sector to feature heavily in this year's Isa choices, benefiting from increased demand from income-starved savers.

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"While there is always the chance of a dividend cut from a BP-style 'event', a diversified dividend stream doesn't need to be badly compromised by a bear market in equities. The income is still largely paid out through the trough and into recovery," Forbes said.

He also suggested looking at absolute return funds, which promise a combination of downside protection and above-average returns. Some of these, however, have failed miserably in their mission to protect investors from volatility.

"There is a good deal of disenchantment with the absolute returns concept," Forbes admitted. "Expectations of almost-consistent positive monthly returns with rare negative months were probably over-hyped and have not been met."

But Forbes insisted that some funds in the sector are worth a look. He cited examples including the Mellon Newton Real Return, CF Ruffer Total Return and Standard Life Global Absolute Return Strategies, all of which focus on "capital-protected" total returns.As Forbes hinted, investors still need to bear in mind the potential for fresh economic volatility, particularly as events in Japan and the Middle East unsettle global markets.

Ken Taylor, managing director of Mackenzie Taylor Wealth Management in Nairn, believes this makes it a good time to invest with the most experienced fund managers.

"A lot of companies are going to struggle, but there are also a significant number of companies who are trading extremely well and hence able to pay rising dividends. to investors. Given the rising inflation figure, this is essential in order to achieve a real return."

Those needing income from their investments should seek some exposure to corporate bonds, Taylor added. "I believe there is still value to be found in the better corporate bond funds, especially for income seekers," he said.

"Concerns about rising interest rates are misplaced, so it is still possible to anticipate decent returns in excess of the best deposit rates," he said.

And Taylor warned against falling for the "flavour of the month" funds so prevalent during the Isa season.

"Avoid the most heavily advertised funds, as you are likely to be disappointed. You are being sold past performance rather than future potential," said Taylor.

It is also vital to keep costs down, as high charges can erode performance over the long term. This is where investment trusts have an advantage, levying annual charges of between 0.5 and 1 per cent, compared with typically 1.5 per cent on unit trusts.

Among investment trusts, the global growth and UK growth and income sectors are once again proving popular with investors, the latter in particular.

The Edinburgh Investment Trust, run by Neil Woodford and yielding about 4.5 per cent, and the Temple Bar Investment Trust, yielding 3.7 per cent, are among the income options favoured by financial advisers.

Gavin Haynes, managing director of Whitechurch Securities, said: "UK blue chip shares are looking particularly attractive for investors seeking income and growth and prepared to take on some stock market risk in their Isa portfolio. Temple Bar is a well-established trust that manager Alistair Mundy at Investec has built up a strong track record since taking over in 2002."

Savers considering dipping into equities should take account of their attitude to risk.

Paul Lothian, chartered financial planner at Verus Financial Planning in Dundee, said: "For a first-time investor with little other savings it's unlikely that any form of stocks and shares Isa would be appropriate, unless it is funded monthly out of surplus income."