This post explains what an Investment or Stocks & Shares ISA (Individual Savings Account) is in simple terms and how to open one. I will share what worked and is working for me when investing within an ISA, while avoiding a lot of technical or confusing jargon used elsewhere. This is not meant to be a comprehensive guide but to only provide information that I found to be essential. For UK investors, a Stocks & Shares ISA is an ideal vehicle to hold any investments which could be used for achieving financial independence.
What is a Stocks & Shares ISA
A Stocks & Shares or investment ISA is a wrapper which can be used to hold many different types of investments for UK investors. The main benefit of an ISA is that any gains from the investment increasing in value and any dividends paid will not be taxed. ISA funds can be accessed at any time, therefore are very different to pensions which are only accessible at a specific age.
Investments which can be held include bond funds, stock index funds and individual shares. Index funds are a collection of stocks which track particular stock market indices like the FTSE, Nikkei or S&P 500. Information on the components of typical index funds is provided in the Top 5 holdings articles.
Important points to know
- Investment ISAs are very different to Cash ISAs which are like savings accounts.
- Funds held in all types of ISAs can be accessed immediately.
- It is possible to put money into both a Stocks & Shares ISA and a Cash ISA in the same tax year (begins every April).
- You should not put money into more than one Stocks & Shares ISA within the same tax year.
- The yearly investment limit (allowance) into a Stocks & Shares ISA is rising from £15,24 to £20,000 from 5th April 2017 for the 2017/18 financial year.
- It is possible to invest a monthly minimum of only £50 a month. The payment can also be suspended if needed.
Here are the essential steps needed for opening and running a Stocks and Shares investment ISA.
Step 1: Find an ISA broker or Fund Supermarket
The first step is to find a broker or fund supermarket, a platform on which you can buy stocks and shares for your investments. The main thing to consider when choosing a platform is the annual management charge as this will significantly impact your long term returns. Charges are typically 0.25% to 0.35%. *In May 2017 Vanguard UK started selling their range of index funds direct to consumers with the lowest platform charge of 0.15%. . Below are examples of lower cost UK fund supermarkets:
Step 2: Determine your Asset Allocation
Asset allocation is the ratio of stocks to bonds in your investment portfolio. It is recommended to hold your age in bonds, for example, a 30 year old will have roughly 70% stocks and 30% bonds. You can adjust this ratio according to your risk tolerance – stocks are more volatile than bonds but offer higher returns over the long term. A tool for determining asset allocation according to age and risk tolerance is available here.
Step 3: Purchase funds according to Asset Allocation
Simplicity and low cost are important here. Once you have selected a platform, choose a selection of low cost index funds for your portfolio. A simple effective sample portfolio is the three fund portfolio.
For UK investors this could contain a UK index fund, developed world index fund excluding UK and a UK government bond (gilts) fund. This type of portfolio will be relatively low cost, really easy to manage, stable and likely to provide good returns.
I recommend funds provided by the Vanguard group. Vanguard index funds are low cost and based on good principles. Index funds are a large collection of companies tracking the intended stock index.
Choose Accumulation (Acc) funds if you are building wealth, as these will ensure that dividends are automatically reinvested, growing your portfolio quicker. Income funds (Inc) pay out dividends to you directly so may be ideal for retirees.
A sample three fund portfolio for a 35 year old is shown below:
|Vanguard FTSE U.K. All Share Index Unit Trust (Acc)||15%|
|Vanguard FTSE Developed World ex-U.K. Equity Index Fund (Acc)||50%|
|Vanguard U.K. Government Bond Index Fund (Acc)||35%|
Step 4: Set up a Monthly Savings Plan (MSP)
A Monthly Savings Plan is an instruction to buy a set amount of shares every month. Ensure that the shares are purchased according to the proportions of your target asset allocation.
Step 5: Rebalance when needed
Rebalancing is getting the portfolio back to the target allocation. This may be needed when one asset class, for example bonds outperforms stocks, resulting in skewing of the portfolio. This does not need to be done frequently, maybe once a year or every two years. Rebalancing can be done by buying more of a particular asset class or selling one asset class to buy the other if needed.
That is all it takes to invest effectively in a low cost, easy to manage, stable and simple portfolio. Using similar strategies I have managed to attain excellent returns on my own portfolio which has outperformed most actively managed funds and stock indices. Act now and invest to immediately take advantage of compound interest.
For further information there are some useful investing books identified on the resources page.
I also find the Bogleheads forums informative and interesting, although it is mostly aimed at US investors. The Bogleheads are low cost index fund investing advocates inspired by Vanguard founder Jack Bogle.