Diversify to accumulate – is this the ISA top-up secret?

People over 50 have only a few days to add an extra £3,000 to their ISAs.

Britons over 50 have just a couple of days to wait till they can access the new and improved tax-free allowance from the Government. But where is the best place to invest their £3,000 top-up?

Individual saving account (ISA) limits will increase to £10,200 for anyone aged 50 or over from Tuesday, while the rest of the nation will have to wait until next April to benefit from the increase. Despite the early incentive, 62 per cent of people aged over 50 questioned in a recent Post Office poll admitting to being unaware of the new limits. Only one in five savers over 50 said they plan to make additional contributions.

Investors who are yet to open a cash ISA can place up to £5,100 in cash, or put the whole £10,200 in a stocks and shares ISA. For those who have already opened an ISA investment, the top-up must stay with the same organisation as rules allow investors to pay into only one cash and one stocks and shares ISA in any one tax year. Even with a flurry of new launches this month, interest rates on cash ISAs are still relatively unattractive unless you're willing to lock your money away for a long time. The best buy from Leeds Building Society pays 4.60 per cent AER, for example, but is fixed for a lengthy five years. In contrast, its one year fixed-rate ISA offers returns of only 2.50 per cent.

Despite the poor rates on offer, many people are still wary of investing their money in stocks and shares and choose to stick with what they perceive to be safe investments such as cash. However, many experts would argue that investing in cash is by no means 100 per cent safe and can be highly vulnerable to inflation in the long term.

"Over a longer investment period, this could actually be a bigger issue than investment risk," argues Daniel Clayden from independent financial adviser (IFA) Clayden Associates.

When it comes to taking risk, investors should ask themselves how much they can afford to lose. It is this figure that will determine the level of investment risk they can realistically take to reach their financial target. The investment time scale will also be a key factor. An investment period of only five years, for example, leaves little opportunity to ride out the peaks and troughs of the market, while over 15 or 20 years there may be enough time to recover from stock market falls.

Although how someone chooses to invest their money will always depend on the personal attitude of the individual, one of the riskiest strategies is to focus on one particular investment area.

"Diversification is not just a simple case of not having all of one's eggs in one basket. It is about having asset classes which behave differently within the portfolio," says Christopher Wicks from IFA N-Trust Limited.

Holding a decent percentage in fixed-interest investment vehicles such as corporate bonds or gilts will minimise risk considerably. When you buy a corporate bond you are, in effect, lending money to a company in exchange for a regular, stable income. Gilts (Government bonds) are considered one of the safest investments as they are backed by the state. However, safer savings alone are unlikely to help investors reach their financial targets, so exposure to riskier investments may be necessary.

"As a general rule, one could expect the over-fifties to have a lower risk profile than say somebody in their thirties. But it doesn't always work out that way. The over-fifties usually have a much more focused approach to saving for retirement, and as a result may need to take greater risks with investments," says Marc Ruse from IFA Fiducia Wealth Management.

Riskier investment vehicles can take many forms, each with their pros and cons, but generally investors can reduce risk though unit trusts and open ended investment companies (OEICs) which are used to invest in a variety of assets such as bonds, property or equities. These can be passively managed via a tracker fund or actively managed by a fund manager.

"UK equity income funds work well as the dividend income can be reinvested to boost the growth, then drawn later to supplement pension income," says Danny Cox from IFA Hargreaves Lansdown. The UK equity income funds Mr Cox favours are Invesco Perpetual High Income and Artemis Income.

Less experienced investors may choose to begin with index trackers which attempt to mirror the performance of particular indices. Here in the UK the main indices are the FTSE 100 and the FTSE Allshare. The benefit of trackers is that they are far cheaper than actively managed funds, as most charge between only 0.3 per cent and 1 per cent per year, with no initial fee. On the downside, critics of tracker funds say that with charges taken into consideration, they are guaranteed to underperform only the index it mirrors. Yet this is true of many managed funds too, which typically have far higher charges levied. The element of risk with this type of investment depends largely on the index being tracked. More adventurous investors may look to the Bric countries (Brazil, Russia, India and China) which are among the biggest emerging markets and have great potential for substantial returns.

"While the West faces negative gross domestic product (GDP), mounting debt and budget deficits, the emerging market economies have strong balance sheets and financial reserves which ensured the region has suffered less of fallout from the global financial crisis," says Nick Price, the manager of the Fidelity EMEA and Emerging Markets funds.

As always, substantial potential for rewards comes hand in hand with substantial risk, and emerging markets carry with them the most volatility in terms of political instability and currency risks. With this is mind, they should form only a small part of a portfolio (about 5 per cent) and should be considered as a long-term investment of at least 10 years.

Investment ISAs by their very nature are not short-term vehicles, so investors should avoid concentrating on individual countries or regions. Neil Mumford from IFA Milestone Wealth Management recommends the emerging economies of Europe, Asia and South America for investors with a long-term investment horizon. However, he advises investors to look at a single emerging market fund rather than choose one key area or country.

"The First State team is in my opinion the most consistent in this market both through good and bad times. The Emerging Markets Leaders fund is my favourite and although it may lag in a bull market, it will certainly minimise the risk in a bear market," says Mr Mumford.

Investors should proceed with caution when it comes to structured products such as guaranteed bonds. With unit trusts, the investment can be cashed in at any time without incurring a penalty. However, with guaranteed bonds investors are far less flexible and investors are hit with a charge if they try to cash in early. And there is no dividend income as there would be from investing in shares directly.

"Investments such as guaranteed bonds need to be approached with great care since they depend on financial institutions, such as the late Lehman Brothers, for the guarantees," says Mr Wicks.

Instead, safety-conscious investors can drip-feed monthly payments into an ISA which will help to smooth out the ups and downs of the market. Although an investor's risk profile will not necessarily correlate directly to their age, exposure to long-term investments should decline as retirement approaches to preserve what has been accumulated. This generally requires savers to move more of their money out of equities and into safer investments, such as cash, gilts and corporate bond funds.

Apart from any pension plan, experts say that people retiring should hold between 25 per cent and 40 per cent of their liquid assets as cash. With tax-free returns that are guaranteed to beat inflation, National Savings index-linked certificates are a good cash investment option and ideal for those looking for more security in their portfolios as they are backed by the Government.

This is also the time to reduce exposure to overseas investments to protect against currency risk. Savers can still access international growth markets here in the UK as approximately 60 per cent of FTSE 100-listed companies generate earnings abroad.

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