As the deadline for the end of the tax year looms, many are rushing to fill their ISA allowance for this year.
But amid the scramble to lock away as much tax-efficient savings as possible, investors should not forget the key investment rules.
Here we lay out the 25 dos and don’ts for investing your ISA.
1. Know your time horizon
Before you can pick what to invest in, you need to know how long you’re going to invest for.
Those in their 30s or 40s, planning to invest until their retirement can invest in assets that rise and fall more rapidly, as over time these riskier investments are likely to result in larger gains.
However, those at or nearing retirement, who are reliant on their investments to fund their lifestyle, will need to reduce the risk. They cannot afford such jumps and falls in the value of their savings.
2. Invest monthly, to avoid timing the market
Ahead of the tax year end there is a rush of money into ISAs. Many will invest a “lump sum” to meet their annual limit of £15,240 for this year.
But investing a lump sum all in one go is the wrong approach. Instead, investors should “drip feed” their money in monthly over the year.
Investment shops allow you to set up direct debits to do this. This strategy means you will benefit from “pound cost averaging”.
This means that as stock markets fall, your regular monthly payment buys more shares or fund units. When markets rise, fewer shares and units are purchased.
This reduces the risk of an investor putting a large sum into the market at the wrong time.
3. Don’t ignore investment trusts (and hunt for discounts)
Investment trusts are “closed ended” funds, as the number of shares issued is limited, unlike a typical “open-ended” fund, which has no limit on the number of units that can issued.
An investment trust is listed as a company itself, and you buy shares in that company. The price of the shares is affected not only by the performance of the underlying investments but by investor sentiment towards its own shares.
This means that often investment trusts can trade at less than the value of their assets, trading at a discount.
This is a great time to buy, as investors are effectively buying the funds when they are on sale. However, investors need to make sure they understand why the trust is on a discount, to ensure there are no underlying problems.
4. Use “passives” where they work
“Passive” funds differ from active funds, in that they do not make calls on the companies they think will outperform and instead buy the whole market.
These funds track an index or market, such as the FTSE 100 index of leading British companies. This means they are lower cost than active funds, and can form a good base for a portfolio.
However, investors should avoid overly complicated passives, or those in too niche markets.
5. Sell your winners and rebalance
Buying investments is easy, but selling is hard, particularly if the fund has been performing well. Numerous studies show that having too many holdings results in lower returns.
The risk with a good performing fund is that it ends up representing too much of your portfolio, and so making your portfolio too reliant on that one fund’s returns.
If you make regular contributions into your ISA or pension, each month, for example, you can use this new money to reset the portfolio, rather than selling and reinvesting in existing funds or shares.
6. Reinvest dividends
If you are invested in income-producing funds or shares, and you do not need the money now you can reinvest the income and boost your investments.
The miracle of compound interest means you get returns on your returns. With funds you need to make sure you buy “accumulation” share classes or with shares ask your broker to reinvest your dividends.
7. Choose the cheapest share class
Many funds have complicated names, with many different share classes.
While some investors may dismiss this as jargon or investment gobbledegook the version you pick can have a big impact on the amount you pay for a fund.
Ask your broker to find the cheapest, retail share class. If you have funds invested directly with an asset manager, check you’re not paying too much.
A rule of thumb is if you’re paying more than 1pc for an active fund or 0.5pc for a passive fund you should check if a cheaper version is available.
8. Don’t just rely on fund tip lists/names you recognise
Many “unknown” fund managers have actually delivered top returns over recent years.
While well-known managers such as Neil Woodford or Terry Smith are popular for a reason, you should not limit yourself to just those managers.
9. Check your fund manager hasn’t changed
Fund managers move frequently, to different asset managers, and they generally do not move their funds with them. This means you need to check that the same fund manager is still running your fund.
If they are not you need to weigh up whether you move with the fund manager to their new employer, assuming they are still running the same type of strategy, or if you stick with their replacement.
Don’t always assume that you should move with the manager, as a lot of their performance depends on the asset manager, the team they have around them and how much time they are given to focus on the fund.
10. Make sure income is sustainable
Many income fund managers will target the highest yield that is sustainable, but some will sacrifice your initial capital in order to generate even more income.
This was highlighted recently in a study of UK equity income managers by Hargreaves Lansdown, the fund shop. It found that the top three funds by income had actually depleted the original investment. This will hit future income.
As Laith Khalaf, of Hargreaves Lansdown, said: “A lower capital base will affect the potential for these funds to generate high levels of income in the long run.”
11. Buy the fewest funds you can
While portfolios need to be diversified, investors can end up spreading their money too thinly across funds.
Sam Lees, at fund research service Fund Expert, suggested 15 funds as the most that any investor should hold. “If your portfolio is 20 funds or more, an overhaul is definitely in order: you will be struggling to keep track of them all,” he said.
However, it depends on what you’re investing in.
There are one-stop-shop funds, that aim to offer a fully-diversified portfolio, which mean you could invest in just one fund. However, if you are spreading your money between different countries and assets, you will need more funds.
12. Make sure your portfolio meets your needs now
People often put their portfolios together and then do not revisit them for a number of years.
But investors should revisit them frequently to make sure they still meet three factors: your attitude to risk, investment time horizon and investment goals.
13. Don’t stick all your money in the UK
British investors, like many others across the world, like to invest in what they know and understand. This means they end up overexposed to the UK stock market.
Research from Vanguard shows that at the end of 2014 (based the latest available data from the International Monetary Fund) UK investors on average had 26.3pc of their portfolio in UK assets, compared to the 7.2pc that the UK represented of global markets.
Allocating more money to “global” funds, that invest in different countries’ stock markets can help to combat this.
14. Have a plan and stick to it
Investors are prone to “activity bias” - the idea that doing something is better than doing nothing - according to Dr Dimitrios Tsivrikos, a psychologist at University College London.
This can lead to needless tinkering with investments, derailing an initial plan and meaning you pay unnecessary fees.
Any changes should be backed by a rational decision making process and hard evidence. Don’t switch out of a fund or stock on a whim.
15. Hunt out old ISAs
Money left in old, forgotten ISAs - whether in cash or invested - can likely be put to better use elsewhere.
Old investments may be stuck in outdated, expensive share classes, or in funds where the original manager has moved on. Old cash ISAs are likely to be earning little to no interest.
You should amalgamate all your ISA holdings into the fewest accounts possible.
16. Don’t hold on to long-term laggards…
The hardest investment discipline is knowing when to sell. Selling on a temporary dip in performance is foolish, but if an investment has been steadily underperforming then you should be ruthless with cutting your losses.
It takes a huge turnaround to recover significant losses - if a fund or stock falls by 50pc, it needs to grow by 100pc to get back to where it was.
17. ...but don’t obsess over short-term performance
All investments are volatile to some degree, and even the best funds will have periods when they lose money.
Checking your ISA every day and fretting over small movements is not productive. If you plan to keep money invested for five years, it doesn’t matter if you are down over a month, especially if your portfolio is well diversified.
18. Check you’re with the cheapest fund shop
The cheapest investment platform, broker or fund shop, depends on the size of your portfolio and how it is invested. Platforms either levvy a percentage fee or a flat charge, and the cost of buying funds and shares varies between platforms.
You should consider the investment selection and customer service of each platform too.
19. Make use of your spouse’s ISA allowance
If you have more money to save or invest than the ISA allowance, one option is to give it to your spouse. There is no tax on transfers between spouses, and they can save or invest it in ISAs under their name.
This move effectively gives you double the ISA allowance - which amounts to £40,000 from next month.
20. Don’t buy a fund just because it has done well
If a fund has performed strongly, the main thing it tells you is that it has made lots of other people money.
Instead, look at the manager’s long-term performance record compared to the benchmark index, and whether the investing style is expected to continue outperforming.
21. Don’t know what to do? Buy a cheap ‘all-in-one’ fund
There are plenty of options available for those who do not want to put together a portfolio of funds and shares themselves.
Vanguard’s LifeStrategy range of low-cost, passive all-in-one funds is frequently recommended by the advisers Telegraph Money speaks to.
Online investment services, or “robo-advisers”, such as Nutmeg, Wealthify, Moneyfarm and Scalable Capital offer another option to take management control.
22. Check you’re not investing in a closet tracker
Paying active management fees for a fund that merely tracks an index is a waste of money.
A fund’s “active share” score will help to tell you how much it differs from the benchmark for its sector, but this is not widely available.
Instead, compare performance charts of a fund to those of its benchmark index, and compare the top 10 holdings of each. If there is too much overlap, you may have a closet tracker.
23. Be wary of “synthetic” ETFs
There are two types of exchange traded fund (ETF). Physical ETFs directly invest in the assets of the index that they track.
Synthetic ETFs use a complex series of derivatives to mirror the performance of an index.
They are typically cheaper, but involve greater risk as counterparties are involved – in a worst-case scenario one of these could go bust.
24. Buy more when you’re down
Panic-selling when an investment falls over the short term is one of the worst things you can do, as selling locks in the loss.
If the investment is for the long term and you still believe in the reasoning behind it, ride out the volatility - you could even buy more after a fall to boost returns when it recovers.
However, if underperformance is sustained, consider cutting your losses.
25. Only invest in what you understand
This adage is one of the most important rules fo investors.
If you don’t understand what a fund invests in, the charges and the risks involved, don’t buy it.
This article was written by Laura Suter and James Connington from The Telegraph and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to firstname.lastname@example.org.
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