Make the most of your tax-free allowances before time runs out

As the tax year comes to an end, banks and investment firms are offering a bewildering number of ISAs. Maryrose Fison reports on the latest products
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The Independent Online

Only two weeks remain before the doors of the tax year slam shut and the chance to rescue a sizeable chunk of your savings from the taxman slips away. You'll be hard pressed to find a UK high street that isn't plastered with posters advertising yet another individual savings account (ISA). But rather than rushing to beat the deadline, it is important to consider what you want to achieve before signing up for an ISA.

If you can afford to invest for at least five years and accept some degree of risk, investing in an equity ISA can make sense. But should you settle for a tracker or pick an attractive-looking fund manager? Danny Cox, the head of advice at Hargreaves Lansdown, says, "Whenever choosing an investment, the main factors are how long you are going to be investing for, how accessible you want your money to be, whether you need an income from your investments and what your appetite for risk is."

The aim of an active investment – where a fund manager invests your money in a variety of assets and shares – is to outperform a benchmark index like the FTSE 100. The theory is that a decent fund manager should be able to produce a higher return than you'd get on a passive fund which tracks an index by automatically replicating it. In simple terms, if one company accounts for 2.5 per cent of an index's size, then a tracker fund will have 2.5 per cent of its assets invested in that company, and so on.

Because of the extra resource needed to manage an active fund, they tend to carry annual management fees of about 1 to 1.3 per cent. Passive investments, by contrast, are generally cheaper with fees nearer 0.3 per cent.

But while passives may be cheaper, it can be risky to invest in one if you aren't prepared to stay in it for the long haul. If the market undergoes another sudden contraction, investments may take years before they break even.

Some tracker funds are also significantly more expensive. Take the Virgin FTSE All-Share ISA, which carries an annual management fee of 1 per cent. Likewise, the Barclays Dynamic Tracker 90 charges 0.75 per cent.

But active investing is not immune to fate. Mr Cox estimates that as many as four-fifths of the actively managed funds on the UK market underperform the index they are trying to beat. It takes an astute investor to seek out the funds that will go on to outperform the market average. If you have the guts to go active, the rewards can be impressive. The Jupiter UK Growth Fund, for example, grew 42.3 per cent in the year to 31 January, while the Neptune Emerging Markets Fund returned 66 per cent.

But, like many things in life, the active investment market is prone to fads. For instance, much has been made of UK stock picker Anthony Bolton's Fidelity China Special Situations Fund of late. The investment house has capitalised on the fund manager's track record as a UK stock picker (his Special Situations Fund produced an average annual return of 19.5 per cent for the 28 years he managed it to 2007), yet China is different. The fund has been criticised for its above-average management charge of 1.5 per cent and punitive performance fee of 15 per cent on growth, exceeding its benchmark index – the MSCI China – by more than 2 per cent. Add to this the fact that performance is relative to the MSCI China index, as opposed to the market as a whole, and it means investors could end up paying a performance fee even if fund falls in value.

Mark Loydall, a director of Cambourne Financial Planning, also warns against exotic investments that capture the imagination but may provide little, if any, value to investors. "There are funds out there which will do wine and fine art but they are very risky. It is not like you can do fundamentals on a case of wine. You can't see what it is earning. With shares, there is a lot of transparent information."

But for people who are torn between actively managed funds and passive investments, one relatively new addition offers an alternative. Asset Allocated Passives – or AAPs – have been on the market for about 18 months and act in a similar way to passives except they invest in multiple tracker funds simultaneously. The theory is that the people running the fund can switch allocations between different trackers as indices rise and fall.

Investment firm Seven Investment Management launched four AAP funds in 2008 which each invest in about 40 tracker funds covering asset classes from equities to bonds, money markets and others. Similarly, Evercore Pan-Asset Capital Management launched two new Pan-Dynamic Funds at the start of this month which work in a similar way to AAPs, but invest in exchange traded funds, which track a specific market, as opposed to tracker funds.

Whichever ISA you go for – actively or passively invested – always remember to look at the bigger picture. Certified financial planner Paul Willans says don't leave your ISA gathering dust: review it regularly and make sure it still matches your goals as they change over time.

"The terms and conditions may mean that any short-term advantage may wither away once the guaranteed period is over," he says. "If you're going for an investment-based ISA, remember the investment can fall as well as rise. Today's best performers may be tomorrow's absolute dogs so it is important, as with any investment, to take good advice at outset and regularly review the suitability of your chosen contract."

FIRST-TIME SAVER: LOOKING FOR STABILITY

James Withers, 27, lives in London and is a motion graphic designer



James Withers decided to put his money in an ISA this year after having a disaster with the investments he put in the collapsed Icelandic bank Icesave. Luckily, he got all his money back, but the ordeal put him off investing for some time.

"It was a terrible experience and after that I put my money back into various current accounts where it has sat for some time." With the help of his independent financial adviser at Gemini Wealth Management, he has opted for a stocks and shares ISA and is in the process of deciding which funds to invest in. His goal is simple: stability.

"I want to feel my money is safe and distributed accordingly. I'm not looking to make a quick buck. These are my savings and I am going to be putting money in regularly for a long time."

MORTGAGE OFFSET: TAX-EFFICIENT WAY OF PAYING IS A 'NO-BRAINER'

Peter McManus, 30, lives in Hampton Court in London and works as a freelance translator



Peter McManus first took out an ISA six years ago and has been using it to offset his mortgage for the past two years. He says it was a "no-brainer" that has offered him multiple benefits.

"My mortgage is £200,000 and I currently have £10,000 in my offset plan, so that is like me paying interest on £190,000 mortgage instead of a £200,000 mortgage."

He found out about the ISA from family members, and prior to setting up the offset plan he had changed it a few times in order to take advantage of the best interest rates. He believes the offset arrangement is a win-win situation. "It's tax efficient and I pay off my mortgage faster."

SHORT-TERM SAVINGS: MAKE THE MOST OF ISAS BY SWITCHING

David Gladwell, 65, is a retired teacher in London



David Gladwell held a cash ISA for 10 years until a few years ago. He paid the maximum contribution each year, about £3,000, and then put the average £150 generated in interest towards holidays. "We used it as a more secure means of short-term saving, because it was fixed and you don't pay tax on it."

David helps his elderly relatives make the most of their savings by switching ISAs each year. "It is important for people to not be afraid to move it each year."

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