How market turmoil is spoiling the ISA party

With less than a month to go before the end of the 2006-7 tax year, it is crunch time for investors to decide whether to use or lose their 7,000 annual tax-free ISA allowance.

And with evidence the three recent rises in interest rates to 5.25 per cent are beginning to have an effect on the nation's spending habits, investment companies could be in for a disappointment.

Jason Hollands, director and head of communications for F&C Asset Management, pointed out that early financial service industry hopes for a bumper ISA season were very much up in the air.

"Investment Management Association figures for net industry ISA sales have been suggesting a disappointing trend, down 71 per cent in January from the previous month and down 62 per cent year on year," he said.

"Our hunch is this is partly due to the three interest rate hikes since August which may be prompting potential investors to focus on paying down mortgages and credit debt rather than commit to the stock market."

He added the sharp falls in global equity markets recently - starting in China almost two weeks ago - could well unnerve potential investors further, although the recovery towards the end of the week will have helped to steady nerves.

While it is difficult to predict short-term market movements, savvy investors will know that setbacks in markets often present great buying opportunities, as long as they are investing on a longer-term horizon. As the saying goes, fortune favours the bold.

Justin Modray, an investment adviser at Bestinvest, said retail investors tended to go against the logic of putting their money into ISAs when shares were cheap.

"Instead of seeing it as an opportunity, they tend to want to wait for an upturn," he explained. "They feel more comfortable after a strong bull run."

Hollands warned it would be a mistake to forgo long-term investment decisions backed up by attractive tax perks simply on the back of short-term sentiment. Equity ISAs, he pointed out, should really be viewed on a minimum of a five-year time horizon.

Annabel Brodie-Smith, communications director of the Association of Investment Companies, agreed: "It's easier said than done, but the best way to benefit from stock market volatility is to take a long-term view.

"Stock markets do not go up in a straight line, and those who hold on to their investments should be able to ride out the highs and lows in the price of shares."

Scottish Widows Investment Partnership's outlook for UK equities remains positive. It said valuations still compared favourably to gilts and equities in other countries. The Edinburgh-based investment house expects the market to perform in line with growth in company profits during 2007, with gains of around 5 to 8 per cent.

With the uncertainty shrouding equity investments, cash ISA providers are hitting back. Abbey, for example, has this week launched a mini ISA at 8.1 per cent to customers who - at the same time - put an equal amount or more into the company's Guaranteed Growth Plan.

For savers who decide to take the cash ISA route, Kevin Mountford, head of current accounts and savings at independent online comparison site moneysupermarket.com, warned: "With the ISA deadline looming and less than a month left before the end of the tax year, people should get their skates on to make the most of this no-brainer savings scheme."