Time to weigh up Isa options

WITH less than a month to go until the end of another tax year, savers and investors are faced with a dilemma: what should they do with their remaining individual savings account (Isa) allowance?

Should they go for a stocks and shares, cash, a junior Isa or a combination of all three? Or with low returns on cash savings rates and the global economic outlook remaining uncertain, should they give them a miss altogether?

Isas are among the most tax-efficient forms of saving, and annual allowances come with a “use it or lose it” warning: they can’t be carried forward to subsequent tax years. Yet millions of people are needlessly paying tax on savings and investments without using up their annual Isa allowance.

So how much, and where, should you invest?

Isa options

Every adult aged 18 and over can shelter £10,680 per year in an Isa wrapper. Up to half of this (£5,340) can be held in cash, with this part of the allowance available to those aged 16 and over. The annual allowance will rise to £11,280 from the start of the 2012-13 tax year on 6 April.

The junior Isa was launched on 1 November 2011 to replace the child trust fund. Parents, grandparents and guardians can open an account for UK resident children under the age of 16, and save £3,600 per child per year. This can be invested in both cash and stocks and shares, with investment returns free of income and capital gains tax. Unlike an adult Isa, the junior version allows switching from shares to cash.

The money is locked away, with the child gaining control of the fund at age 16 and access at age 18. Other means of saving for children could give greater control and flexibility.

Cash savings

With investors fretting over the Eurozone debt crisis and the possibility of a double-dip recession, stock markets have been prone to volatility as rattled investors exit “risk” assets. Many Isa savers will, therefore, appreciate the flexibility of stashing half of their allowance in cash. If you choose a cash Isa your capital is safe, but if you don’t secure a rate that outstrips inflation, your cash will lose value in real terms.

The retail prices index (RPI) measure of inflation stood at 3.9 per cent in January, and the vast majority of cash Isas fail to match this: some pay as little as 0.1 per cent. Interest rates have been at a historic low of 0.5 per cent for the past three years, but remember that at some time in the future they will increase. If you use each year’s Isa allowance you will have built up a tidy sum on which you will be able to enjoy tax-free interest.

Fixed-rate cash Isas offer the highest rates. Aldermore pays 3.35 per cent over one year and RBS pays 3.9 per cent over two at present, in both cases on balances of £1,000 or more, data from Defaqto shows.

Only save in a fixed-rate account if you know that you won’t need the money for the duration of the term; early withdrawals or transfers are likely to be subject to an interest penalty or not permitted. Also avoid locking in for too long or you won’t benefit when interest rates do start to rise.

Accounts with a guaranteed introductory bonus could be a good home for your cash. Cheshire Building Society pays 3.06 per cent on deposits of at least £1,000, including a 2.06 per cent bonus until 30 September 2013.

Stocks and shares

Stocks and shares have historically yielded far superior returns than cash, and there are ways you can minimise risks. Investors who made Isa subscriptions through the Skandia Investment Solutions platform in January opted for the relative safety of equity income and bond funds. UK fixed interest was the clear winner, accounting for just over a quarter of sales, followed by UK equity and managed funds.

Many UK blue chip shares offer yields of 3 to 4 per cent, as well as the potential for capital growth, while corporate bonds are typically yielding 4 to 5 per cent.

While opting for these relative safe havens could be a savvy move, it’s more important to ensure you have a diversified portfolio. Last year is a good example of the unpredictability of sectors and markets. Investors in gilts had a stellar year, with returns of 15.8 per cent, according to the Barclays Capital’s Equity Gilt Study 2012. Those who backed commercial property posted profits of 8.1 per cent, data from IPD shows, while investors in UK equities suffered losses of 7.8 per cent. And, despite hype about gold, the precious metal fell nearly 20 per cent in the final few months of the year.

A relatively new style of investment management has emerged in response to investors’ need for greater diversification to smooth investment returns. Multi-asset investing has been used by family offices for decades, but has recently become more widely available to mainstream investors.

This approach diversifies investments across many more asset classes and styles than a traditional UK stocks and bonds dominated portfolio. For example, London-based Saltus Fund Management includes distressed debt, hedge funds and commodities within its multi-asset portfolios. While these might appear “exotic” asset classes, they can reduce overall volatility and risk if managed correctly.

Jason Hemmings is a partner of Edinburgh-based Cornerstone Asset Management