Save your stocks & shares ISA from deadline disaster
The 2014/15 tax year ends on Sunday 5th April, so there's not long left to use your £15,000 ISA allowance or lose it forever.
Unfortunately, in an eleventh-hour rush to take advantage of each year's allowance, many investors hastily throw their money into investments. Therefore, if you want to avoid wrecking your future wealth with unbalanced ISA investments, be sure not to make these five crucial mistakes.
1. Chasing 'hot' stocks or funds
Possibly the worst thing you can do with your ISA cash is to pile it into the latest 'red-hot' shares, because today's stars frequently become tomorrow's dogs. The worst-case scenario is to pour your money into a share that your mate Dave recommended down the Dog & Duck.
The same advice applies to hot funds, because they too can quickly go stone-cold. Remember how everyone piled into dotcom funds in the late nineties, only to lose their shirts when the technology market crashed in 2000?
For example, take the first six months of last year, when UK investors poured £7.3 billion into the top-10 best-selling actively managed funds during 'ISA season'. According to investment firm Wealth Horizon, £4.7 billion of this total went into funds that underperformed for the remainder of 2014.
In short, just because a share or fund is popular does not mean that it will beat the market. So rather than focusing on funds and shares that are being heavily marketed and recommended, focus on building a portfolio that meets your specific goals and attitude to risk.
2. Piling in all at once
Another fundamental mistake that investors make is to mess up the timing of their ISA investments. Instead of drip-feeding money in over a period of time, millions of us throw lump sums in on a single day, often just as the end of the tax year looms.
The big problem with piling 'all in' at the end of March or April is that you can easily become a victim of one of the stock market's seasonal effects. It is a well-known phenomenon that the London stock market often rises in late March and early April, pushed up by a flood of cash flowing into ISAs as tax years roll over.
A far less risky approach is to spread out your ISA investing throughout the year, taking advantage of market weakness to top up your holdings. Also, to automate the entire process, why not divide your ISA allowance into 12 chunks and then invest monthly?
3. Having too few eggs in your basket
One of the oldest and best ways to lose money from investing is by having a heavily concentrated portfolio. In the good times, having a highly focused portfolio can bring bumper returns, especially during one of the market's periodic bubbles. However, when bubbles burst, far better to have a well-diversified portfolio than to be nervously holding a basket with one giant egg in it.
Indeed, research conclusively shows that diversifying your portfolio produces better risk-adjusted returns in the long term.
That's why it's wise to review your existing assets before piling into shares, funds or other assets as ISA deadlines loom. Otherwise, sticking the whole £15,000 into one company or fund could leave your portfolio dangerously unbalanced for an entire year or more.
4. Ignoring the rest of the world
As each ISA season comes around, ISA firms and investment brokers fill the newspapers with their latest offers and 'must-have' funds. One serious problem with these heavily promoted funds is that so many are UK-focused, with a particular emphasis on the UK Equity Income sector.
Although the UK has the world's sixth-largest economy, we Brits account for only a thirtieth (3.3%) of world output and are a mere 0.9% of world population. So by having heavily UK-centric portfolios, British investors risk missing out on possibly superior returns on offer from other developed and developing nations.
For example, according to Moneyfacts, the average stocks and shares ISA has returned 7.4% so far this tax year. However, among the standout markets for ISA funds during 2014/15 are North America (18.9%), Japan (17.3%) and China (16.8%) – all of which have thrashed returns from UK-focused funds.
Therefore, when choosing your ISA (last-minute or otherwise), don't overlook the opportunities available in the rest of the world.
5. Mismatching income and growth
The final tip to create a properly balanced ISA portfolio is this: don't buy growth investments when you need income, and vice versa. If you want a regular income, look for investments that are likely to pay a dividend. If you want capital growth over time, seek out investments that look undervalued.
Also, although all capital gains and most income made inside ISAs is tax-free, if you have more than £15,000 to invest it can make sense to put income-generating assets, which would otherwise lead to a tax charge, into ISAs and hold growth-focused assets, which would be liable to Capital Gains Tax (CGT) if you sold them at a profit, outside of this tax haven.
This is down to peculiarities in the UK tax system. The maximum rates of income tax are 40% for higher-rate taxpayers and 45% for additional-rate taxpayers. However, the top rate of Capital Gains Tax (CGT) is just 28% and so, for most investors, CGT rates are higher than taxes on income. Also, each UK resident has a CGT allowance of £11,000 for 2014/15, giving plenty of scope for CGT-free gains.
Having said that, if you're investing £15,000 or less, it's always make sense to use your ISA allowance.
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