With dismal rates on cash Isas there is another option for maximising returns: stocks and shares. If you're willing to take some risk and aren't likely to need the cash anytime soon, investing in a stocks and shares Isa could be the best way to make the most of your money.
After all, history shows that over the years these accounts have the potential to grow faster than cash held on deposit, if you pick the right investments. But how do they work? It's vital to make sure you understand the basics before taking the plunge. Here, we answer some of your questions: What is a stocks and shares Isa? Simply put, it is an investment account held in a tax-efficient Isa 'wrapper'. By holding your investments this way you benefit from various tax advantages, although there is an annual limit on how much you can place in an Isa. Also known as equity Isas, stocks and shares Isas can be invested in a variety of funds, individual stocks and shares, as well as fixed-interest investments such as bonds.
You take more risk with a stocks and shares Isa compared to cash as your money is subject to stock market volatility. Yet the upside is the potential for higher returns over time if you are willing to hold your nerve.
What are the tax advantages? Despite tweaks along the way, the Isa remains an attractive savings and investment account for its tax-efficiency, enabling you to keep some of your hard-earned cash out of the taxman's grasp.
There are several advantages to holding your investments in an Isa wrapper, including the fact that any profits made from share price increases aren't subject to capital gains tax.
Also, dividend income, or the income paid out by shares, is taxed at 10%, which results in a substantial saving for higher and additional rate taxpayers who typically face higher tax rates. Finally, you don't have to detail a stocks and shares Isa on your annual tax return, reducing the piles of paperwork in the run up to this deadline.
How much can I hold in a stocks and shares Isa? You're allowed to put up to £11,520 in 2013/14, minus any sum you have put into a cash Isa (which could be up to £5,760). Like cash Isas you have until the end of the tax year, 5 April, to open an account and place your money in it. However, you don't have to invest the full sum held in a stocks and shares Isa by that date – you can place this in a holding account and, for instance, drip feed it into the market.
What are the rules when investing? Remember that once you've invested your annual limit you cannot pay more in, even if you have made a withdrawal. For example, say you pay in the full £11,520 but take out £1,000 the next month, you can't put that £1,000 back in your Isa in the same tax year – even though your Isa holding may be below the limit, you've already used your annual allowance, and will have to wait until the next tax year to open another stocks and shares Isa. Whatever sum you withdraw from the fund will lose its Isa status, so the rules are quite rigid.
How many stocks and shares Isas can I have? You can open one stocks and shares Isa each tax year. So you can build up a number of accounts over the years if you wish, allowing the sum invested to grow over time. However, if HM Revenue & Customs notice you have already applied for an Isa in the tax year, the application will be rejected.
Where can I get hold of one? There are various options, depending on the type you want to buy. Stocks and shares Isas can be bought from independent financial advisers (IFAs), fund supermarket, a financial broker, and through high-street banks. Which is right for you depends on your level of investment knowledge, whether you're prepared to monitor the fund yourself, and what type of investments you want to hold.
If you're comfortable making the investment decisions yourself, you may choose to open a stocks and shares Isa through a fund supermarket for the widest choice of investments. Even a first-time Isa investor may want to choose this route as it's unlikely to be worth paying for advice unless you have a large sum to invest outside of your annual allowance.
So how much will I pay for a stocks and shares Isa? Unlike a cash Isa, a stocks and shares Isa will cost you something to set up. How much depends on how you invest – if, say, you choose the adviser route, you'll pay for the adviser's fees alongside the fund charges. However, if you opted for an account through a fund supermarket you'll pay its annual charge as a percentage or flat fee, alongside the fund's costs.
Funds typically charge an initial set-up fee of up to 5% alongside an annual charge of between 1% and 1.5%, although these fees are often discounted when bought through investment websites. Also, some companies reduce their charges during the Isa season, which runs for the few months before the end of the tax year on 5 April. You can compare the cost of websites on which investors can manage their money at www.comparefundplatforms.com.
If I want to invest should I start paying into one now? Maybe. It depends on how much money you have to spare and how much risk you want to take with it. If you have a fair amount to which you don't need instant access for the next five years or so, you might want to take the plunge and start a stocks and shares Isa before the 5 April deadline. The stock market performed well in 2013, and many expect it to soar again this year. And remember, you can drip feed the money into the market for gradual stock market exposure.
Can I move my stocks and shares Isa to another provider? There's nothing to stop you, provided you follow the golden rules. That means avoid withdrawing the sum to reinvest elsewhere. Instead, use the transfer form provided from the new provider to request the move is done without losing the Isa status of your investments. Any money you have in a cash Isa can also be moved to a stocks and shares Isa by following the same process, but you can't transfer back into a cash Isa once this money has been made.
Ordinary savings accounts or stockmarket investments outside an Isa can be transferred to one of these tax-efficient accounts, provided you stick to the allowance limit. This will allow you to start your savings in a cash Isa, say, if you don't want to risk them on the stock market, and then roll them over into stocks and shares Isas when you've built up a larger fund and are happy to take the risk.
What if I want to hold more esoteric investments in my Isa? You can hold lots of different investments in an Isa, such as exchange traded funds and investment trusts alongside traditional stocks and shares.
However, check you are able to hold the investments you want and what charges apply. Fund supermarkets operate separate charging structures for investors who want to buy these investments as part of their Isa. Self-select Isas are often a good route to go down if you want to include more esoteric assets.
What happens to my Isa when the new tax year starts? You won't need to do anything, as your Isa will continue to move in line with the market. In the next tax year you can decide whether to add to it or start a new one with a different provider.
However, remember that once a monthly payment has gone into the Isa after 5 April you will have used some of the next year's allowance. So if you already have an Isa and want to shop around for an account elsewhere for next year you need to ensure this doesn't happen.
What happens if the value of my stocks and shares Isa falls? If you're not happy with performance, you can switch from one investment to another within the Isa wrapper. However, if you just want to hold funds and buy an Isa direct from a fund manager, you may find you have access to a limited choice of investments if you do want to switch. It's better to buy from a discount broker or fund supermarket if you want a wide choice of investments, and this may also be lower cost.
Fund tips Low-risk investors: You want to take greater risk than with cash, but would like to take a cautious approach.
Cazenove Multi Manager Diversity Patrick Connolly from IFA Chase de Vere says: "This is an ideal choice for a novice or cautious investor, essentially being a whole portfolio in one fund. It invests one-third in equities, one-third in cash and fixed interest and one-third in alternative investments such as property and long-short funds. Fund managers Marcus Brookes and Robin McDonald have a good record or providing consistent returns while protecting investors' money and this fund also has competitive charges compared with other multi-manager offerings." JOHCM UK Opportunities Juliet Schooling Latter from execution-only broker Chelsea Financial Services says: "This fund aims to generate positive returns over the long term. The managers, John Wood and Ben Leyland, look to find quality companies at attractive valuations, to build a portfolio of 30-40 stocks. There is a 15% performance fee on out-performance of the FTSE All-Share, but the annual management charge is lower than most at 1.25%. John is cautious and holds a higher than normal amount of cash in the portfolio." Medium-risk investors: You're prepared to take some risk in pursuit of greater rewards with a mix of investments.
Rathbone UK Income Connolly says: "This is an equity income fund with a current yield of 3.7% per year. It has been managed by Carl Stick for 14 years during which time it has built up a decent performance record. The fund invests in more mid and small cap companies than many other equity income funds, meaning it can provide good diversification alongside other holdings. It also pays huge attention to managing risks with the focus on looking for well run companies with good cash flow." Rathbone Global Opportunities Schooling Latter says: "The fund's portfolio will consist of 50-60 stocks from developed world markets, with manager James Thomson searching for companies with potential for growth. His approach can lead to periods of volatility in unsettled markets, but the fund has a defensive bucket of stocks to give it a cushion during market slumps." High-risk investors: You have a particularly long-term time horizon, and have some experience of investing.
AXA Framlington American Growth Connolly says: "This is an out-and-out US growth fund with large weightings in technology, healthcare and consumer stocks. As a result it is likely to be more volatile than many other funds in the sector and have periods of out-performance and under-performance. If you take the argument that the US economy is on the road to recovery this fund should be positioned to perform well." Legg Mason Japan Equity Schooling Latter says: "This aggressively managed Japanese equity fund has a small and mid-sized stock focus. The highest volatility fund in the sector, this fund is prone to long periods of under and out-performance, but if the Japanese economy continues to do as well as it has done over recent months, the fund should do very well." Find the best Investment ISA at Moneywise Compare