Ken Taylor: A simple rule on Isas: look forward to find growth, not back

Add to this the fact that virtually every year the vast majority of Isa investments find their way into a select band of heavily promoted products and you begin to appreciate how the inflows into funds can be easily distorted at this time of year.

The current maximum of 10,200 is one of the few tax allowances that the government still offers and should therefore be taken up whenever possible. It is worth offering some observations on Isas and asking why they are too frequently shunned by investors.

Funds are typically marketed on the basis of past performance, which leads unwary investors into choosing (or being recommended) funds that are destined to be among the poorest performing in future years.

Think back to the technology boom, when we were being told to buy funds that had tripled in value over the previous five years. What happened next scarred an entire generation of investors.

I was recently at a conference where this phenomenon was analysed in some detail. The concept of behavioural finance is truly revealing, and at its very core sits a condition from which too many investors suffer: myopia. In simple terms, this means that our perception tends to be based on our most recent experience and is therefore backward-looking.

The ability to avoid such a condition is hugely advantageous in investment, as it almost guarantees adopting a contrarian position.

Applying the above, I suggest that investors would do well to look beyond short-term underperformance of an index by their chosen funds, as such benchmarks are too often misleading. The FTSE 100 index, for example, has five companies which represent 35 per cent of the entire index, and ten representing 55 per cent. This implies huge concentration and potential risks that are best avoided.

Another golden rule is to avoid investing in something you do not understand. How many of us have invested in structured products in past Isa seasons, only to be disappointed?

In terms of where the majority of new monies are currently being placed, emerging market equities are top of the list. Prepare to be bombarded with compelling statistics of sensational GDP growth and little (if any) exposure to the debt woes of western economies. Whilst in isolation these claims are largely true, there will be no mention of the growing inflationary problems such economies are facing.

Increases in raw material prices, energy costs and wage demands are all gathering pace and will inevitably have an impact on corporate profit margins. In contrast, things in the western economies are very different.While we are all becoming increasingly aware of the impact of our fiscal deficits and unemployment continues to grow, it is important to be remember that many companies are trading extremely well, having used the recessionary period to become increasingly efficient through de-stocking and cost reduction processes.

Additionally, the valuation of such companies remains relatively attractive, especially for those that enjoy global brand status. These firms are less exposed to an overstretched domestic consumer but benefit from supplying growing demand in emerging economies.

Such businesses generate strong cash flow and therefore over time they are able to grow the dividends for their investors significantly. More than ever this is a time to remember that the vast majority of total return for equity investors is represented by reinvested dividends.

Given that we are highly likely to experience higher volatility in equity markets throughout this year, seeking exposure to such companies is highly recommended.

In summary, I would urge investors to fully utilise their Isa allowances, and to do so without looking backwards. If possible, avoid leaving decisions until early April and remember that investment decisions are for the long term.

However unsettling short-term volatility can be, if you have made a sensible, considered investment choice then you are highly likely to be rewarded over the coming years.

• Ken Taylor is director of Mackenzie Taylor Wealth Management