You need to time your ISA just right

Waiting until the end of the tax year to invest your entire individual savings account allowance could cost you, says Samantha Downes.

The banking sector's troubles caught many investors by surprise (Getty Images)

Timing is crucial when it comes to investing in a stocks and shares individual savings account (ISA). As tempting as it may be to wait until the deadline – which this year is on Thursday (5 April) – it pays to spend time and effort spreading your payments throughout the year.

This year savers can put up to £5,340 in cash or £10,680 in funds or shares.

But then there's a quick opportunity to use next year's tax allowance. Starting from 6 April you can put a further £5,640 in a cash ISA or £11,280 in an equity ISA.

With cash ISAs currently paying around 3.5 per cent, adventurous investors may want to try their luck with a stocks and shares version – and investing at the beginning of the tax year can really pay off.

Although stocks and shares ISAs are risky there is the potential for greater returns, but investors really have to hold their nerve.

According to Fidelity, someone who invested their full allowance at the beginning of each tax year since 1997 in companies listed on the FTSE All Share would have achieved an annual return of 5.55 per cent. However, the return would have been achieved only if they had invested consistently over the last 15 years.

Even with regular saving, timing is absolutely crucial.

Danny Cox, an adviser with Hargreaves Lansdown, said investors who stayed with their investment would have made most of their returns during 10 separate days when the stock market soared.

He said: "If they had not been invested in the stock market on those 10 days, during which the market soared, they would have achieved average annual returns of just 1.32 per cent."

That's right: just 10 days out of 15 years made the difference between earning 1.32 per cent and 5.55 per cent a year on an ISA invested in UK companies.

Darius McDermott, an adviser at Chelsea Financial Services said: "The industry adage is it is time in the market that counts, not timing the market.

"This is because it is nearly impossible to time the market correctly and by missing just a few of the best days, you can significantly impact your pot of money trying to do this. It's therefore usually better to stay invested.

"Even when markets are volatile, the important thing to remember is equity investing is for the long term. Remember your goal and stick to your plan."

Mr McDermott and Mr Cox believe that for most investors, having a regular savings plan which drip-feeds money into the market is the best way to maximise any returns the stock market may generate. This investing strategy is known as pound cost averaging.

Effectively, it means an investor can smooth out market highs and lows; while they may be buying shares when markets are high, when the market falls they will end up buying more shares at a cheaper price.

Mr McDermott said: "Of course, this means when it rises you will buy less, but the shares you bought before will be worth more."

Another way to maximise your ISA allowance is to spread your investment across different types of investments such as bonds, property, equities, commodities and cash.

"Then, if one asset class is not performing well, another usually is making your investment ride less bumpy," said Mr McDermott.

He also believed investors should look at actively managed funds. These are funds whose managers make day-to-day decisions on which companies to drop and which to include.

"During times of market volatility, expert, active fund managers can really make a difference for you – hopefully losing less money when markets fall and making more when they rise. Index-tracking funds can't do this," Mr McDermott said. "Tracker funds which try and mimic the performance of an index are more inflexible when it comes to riding out volatility. During the banking crisis, UK trackers were stuck with high weightings to UK banks, for example."

David Jeal, head of product management at the share trader Selftrade, said that investors could save as little as £50 a month.

"Regular investment services will usually let you do this for a lower trade fee too. And most of these start from £50 a month to encourage people to get into the habit of saving/investing."

Although it may seem nerve-jangling, Mr Jeal urges investors to consider buying when the market is low.

He said: "The market will drop, then you go in and buy shares. When it goes up you can in theory make more money. If you are drip-feeding money in you only risk that money and not all of your fund."

Those wary of investing in the stock market should take advantage of their annual ISA allowance.

Edward Johnson at the discount broker Willis Owen said: "We know there are many savers who don't want to lose this ISA allowance but are not sure where to invest right now. If that is the case, they can put their money into a cash ISA."

Investors can then drip-feed that money into a stocks and shares ISA at a later date, without losing their annual allowance.

He said: "The reality is it is very difficult to time the market right. If you could, you would be a very successful trader and make millions.

"Investing on a regular basis means you are dealing with more controllable amounts and eliminating some of the market timing."

Andy Parsons, head of investment research at The Share Centre, suggested three funds for ISA investors looking for long-term returns.

He singled out the Newton Real Return fund, the Invesco Perpetual High Income fund and the M&G Optimal Income fund.

Mr Parsons said: "The Newton Real Return fund targets cash +4 per cent and uses a three-pronged approach to maximise opportunity and minimise risk. The fund currently has more than £5.3bn in assets under management, making it one of the largest in the absolute returns universe and also boasts a strong track record of steady returns and low volatility.

"The Invesco Perpetual High Income fund, run by Neil Woodford, is one of the very largest actively managed funds within the UK, with assets under management currently totalling around £11bn. The sheer size of the fund ensures it sits very comfortably as the largest in terms of assets under management within the highly competitive UK Equity Income arena."

The M&G Optimal Income fund was well-positioned for low-risk, experienced investors looking for a predominantly debt-focused investment opportunity, Mr Parsons said.

The fund is managed by Richard Woolnough and has the flexibility to invest across the entire bond market – as much as 100 per cent in gilt or high-yield debt.

"Total returns are prioritised ahead of income, albeit the current yield of around 4.39 per cent makes it an attractive investment for those income seekers who are looking to help supplement their lifestyle."

Mr Cox said this month's Budget had been a sharp reminder of the importance of using up the ISA allowance.

He said: "The numbers of people paying higher-rate tax will now increase by 1.3 million to 5 million, according to the Institute for Fiscal Studies, and the merger of age-related allowances with the personal allowance will cost the over-65s £3.3bn. ISA income is free from further income tax and therefore unaffected by these two tax rises."

Neil Shillito, a director at the advisers SG Wealth Management Ltd, said: "There should be no such thing as an ISA season. It's a misnomer; investors need to be looking all-year round.

"Don't fall for the marketing hype of it being ISA season. Make an ISA one for the whole year, not just Christmas or Easter."

Case studies

The small, but regular investor

Paul Wynn is 47 and lives near Shrewsbury. He has been investing £100 a month into the Liontrust Special Situations fund for the last three years.

"I can't afford to put large amounts away into a pension at the moment. We started a business and because of the recession we are holding tight. However,it's important for me to save," he said. "I understand that investing in the stock market is a long-term plan and at some point we may increase. I know that I can forget about that £100 for the moment. It's important to be able to keep drip-feeding some money into my ISA."

Building up a nest egg

Dannielle Jones, 57, from Bath, has been putting lump sums of variable amounts into an ISA for 10 years.

Her ISA allowance is split between three funds: the Schroders UK Mid 250, Schroders UK Alpha Plus, and Schroders Japan Alpha Plus funds.

"My fund is now worth £25,000 and I'm saving it up for my family. I want to be able to have a nest egg for my sons when they get married," she said.

"I tend to put amounts in when I can afford it rather than have a monthly sum, but it has done well.

"Even though I do put in lump sums I do try to make sure it is as regular as possible."