Faith Glasgow reveals how you can get more from your stocks and shares ISA.
It’s always worth ensuring that your ISA investments are working as hard for you as possible – but never more so than when actual investment returns are thin on the ground, as they have been over the past year and may well be in the coming months.
To put the extent of the challenge facing investors over the past 12 months, figures from Morningstar found that of the 794 funds in its dataset of UK-domiciled rated funds, only 134 – around 13% – achieved any positive growth at all in 2022, with just 21 pushing into double-digit returns.
It’s just the kind of situation where informed ISA management can help minimise the risk of further losses and pave the way for your investments to deliver their full potential, as and when markets eventually pick up.
So, whether you’re looking at the state of previous years’ ISAs or contemplating a new investment before the tax year ends, what can you do to boost your portfolio returns over the longer term?
1) Regular investing
In choppy markets, investing a lump sum can be a high-risk strategy, given the chance of further falls in coming weeks or months. Instead, why not put as much as you can afford into your ISA as cash and then set up a regular savings plan to drip-feed it into your chosen funds over time?
The big advantage of regular investing in this context is that you benefit from so-called pound-cost averaging.
- The seven deadly sins of ISA investing
- My ISA goals for 2023: why I’m feeling ‘queasy’ but quietly confident
Your money goes into the market each month come rain or shine, so you don’t have to make difficult decisions about it. In the ‘down’ months, it buys more investment units and in the ‘up’ months it buys fewer; but over a set period of volatility, pound-cost averaging means you’re likely to pay less per unit on average (and therefore own more units) than if you’d invested a lump sum at the start.
2) Be a contrarian
You may not feel comfortable about buying “when there’s blood on the streets”, as financier Nathan Rothschild advised. But if you are investing for the long term and have cash sitting in your ISA, the cleverest time to use some of it is when falling markets have brought prices down significantly for your favourite high-quality funds or stocks.
3) Don’t hold too much cash
Cash has a valid role in any ISA, for example in situations such as the two above. You may well want to keep some cash as a ‘war chest’ to invest when prices are low, or just to diversify your assets.
But remember that if it’s not actually in the stock market, that money isn’t working for you. It may earn some interest, but it’s losing real value in the face of much higher inflation.
It makes more sense to look at all your assets holistically and keep a separate cash cushion in an easy access account for domestic emergencies or treats. That way, you can make the most of your tax-free investment opportunities.
4) Reinvest everything
If you don’t actually need to take an income from your investment, then please, please don’t. Instead, opt to have any earnings automatically reinvested (this is what will happen if you select accumulation class fund units).
Dividend reinvestment over the long term makes an enormous difference to the performance of your investments, because those reinvested dividends are used to buy additional units or shares, which themselves then produce dividends that can be ploughed back in, and so on.
For example, £10,000 invested in a FTSE 100 tracker at the start of 1986 would be worth £53,400 by the end of 2020 if dividends had been withdrawn. If they had been reinvested, however, it would be worth a meaty £196,000.
That’s the power of compounding. It becomes increasingly significantly as your investment grows over time, so it’s a really big deal if you want your ISA to be a significant element in, say, your retirement plans (or any other long-term goals).
5) Rebalance your holdings
Over time, it’s inevitable that some investments in your portfolio will be more successful than others and come to account for an increasingly large proportion of the total. And it can be very tempting simply to hang on to the winners as they grow.
But received wisdom says that it’s sensible to review your portfolio regularly and trim your exposure to the fastest-growing holdings. You can then use the cash to top up those that seem relatively undervalued.
Why bother rebalancing? If you don’t, the danger is that over time the fortunes of your portfolio as a whole become more and more dependent on the most successful holdings; and at the same time that the holdings in question may become over-valued because of that success.
When one (or more) subsequently falls out of favour – and that is bound to happen at some point – you’ll take a much nastier knock than if you’d kept its value as a proportion of the whole portfolio under control.
6) Embrace risk
As a long-term investor, you are in a privileged position. You can afford to look at your holdings in terms of decades rather than years – and that means you can invest in those parts of the market that offer higher potential returns over the long term but with greater short-term risks attached.
That is not to say you should channel your entire ISA into smaller companies, emerging markets or environmental solutions funds – see point 7 below. However, you can afford a decent level of exposure, depending on your stomach for risk.
- Why I’m sticking with my racy growth portfolio
- My pension dilemma: how much risk should I take in 2023?
For instance, experts suggest you might choose to hold up to 25% of your portfolio in smaller company funds and maybe 10% in emerging markets.
As you’ve probably picked up already, a mix of holdings is sensible for any canny ISA investor. Aim to diversify across geographical regions, market capitalisations, investment styles, asset classes and fund managers.
The argument is that focusing on just one type of investment leaves you dangerously exposed, because things will inevitably go wrong eventually and you’re very unlikely to be able to time your exposure to markets to avoid them. It’s therefore better not to try, and instead simply to spread your interests across a range of holdings that respond differently in different situations.
If your ISA is well-balanced, it’s likely that at any one time some parts of it will be outperforming, even if others are suffering. The goal is to minimise the ups and downs in your overall portfolio value, while at the same time achieving good, reliable returns overall.
8) Reduce your fees
Finally, take a step back from the investment coalface to make sure you’re not overpaying for your ISA account. All else being equal, the more that goes on fees, the less of your money is being put to work in the markets.
Some brokers charge percentage account fees (that may be tiered or capped above a certain portfolio value), which means that ISA customers will pay more as their portfolio grows in value.
Others, including interactive investor, operate on a flat-fee basis. For portfolios worth more than £25,000 or so, a flat fee arrangement is generally cheaper, as you’ll pay the same account charge for a portfolio worth £30,000 or £30 million.
Platform consultant The Lang Cat has crunched the numbers to show the difference ii’s flat fees can make to a typical portfolio’s value after 30 years, compared with those of leading percentage-based brokers – it’s quite an eye-opener.
Look also at the costs attached to buying or selling investments. Be warned – these can be difficult to compare, especially as some brokers offer preferential rates for frequent traders. But unless you’re doing a lot of buying and selling, the account charges are likely to be more significant.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
Please remember, investment value can go up or down and you could get back less than you invest. If you’re in any doubt about the suitability of a stocks & shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.