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Six must-ask questions for all ISA investors

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With just under a month to go until the end of the tax year, it is decision time for last minute ISA and SIPP investors.

Making the sensible choice not to miss out on these tax breaks is unfortunately just the start.

As both ISAs and SIPPs are nothing more than tax wrappers, you still have to decide what to put in them.

Tom Stevenson, investment director at Fidelity Worldwide Investment, talks us through the key considerations for every saver:

1. Cash or stocks and shares? 

The answer this year is a relatively easy one because the rates on cash are so pitiful. This is in part a result of the Government’s funding for lending scheme which is designed to encourage banks to lend more by giving them access to cheap funds. It has been more successful than many imagined and cheaper mortgages have been one welcome consequence for borrowers.

For savers, the result has been less happy. Banks are no longer competing with each other for savers cash and so cash ISA rates this year are even worse than they have been in recent years. This is one reason why Fidelity has seen savings into Stocks and Shares ISAs increase by around 40% in the first two months of this year compared to the same period last year.

Four years after interest rates hit a 300 year low of 0.5%, many reluctant investors are accepting they will have to take some level of risk in order to have any chance of achieving a higher income.

2. Bonds or equities? 

Once you have decided to take the plunge with a stocks and shares ISA, the next question is whether you want to invest in shares or bonds.

In recent years, investors have favoured bonds because they have historically been less volatile than shares and, in an environment of falling interest rates, have also enjoyed equity-like returns. It has been a very attractive combination for many people, especially those reluctant refugees from cash accounts.

Today, however, the relative attractions of shares and bonds are much more finely balanced. Some have talked about a “great rotation” out of bonds and into equities although the evidence on this is mixed.

Equities offer income and the potential for growth but more volatility. Bonds also offer income and lower volatility but probably less prospect of a capital gain than in recent years.

There’s no right answer to this question and many investors will still decide they want a bit of both in their portfolios.


3. Home or away? 

The UK economy is bumping along the bottom and Britain has lost its prized AAA credit rating. There is even talk of an unprecedented triple dip recession. It is not hard to see why investors should be wary of investing at home.

However, the UK stock market is one of the most international. Many of our leading companies earn a high proportion of their profits overseas and this has led to a mismatch between the performance of the UK economy and that of the London stock market.

Shares are trading close to a five year high and have regained almost all of the losses since the financial crisis erupted in 2008. People are rightly more comfortable investing in companies they are familiar with and which they can track in their daily newspaper.

And UK companies offer very attractive income yields today. However investing in Asia and other emerging markets remains very popular.

Investors seem to be taking a barbell approach – half at home and half away. In an uncertain environment, that seems pretty sensible.”

4. Developed or emerging markets? 

The world is clearly rebalancing towards big developing economies like China and India. But US tracker funds also remain popular and there are a couple of good reasons for this.

First, the American economy is recovering more strongly than most thanks to the decision (correct in my opinion) to delay restoring fiscal discipline until growth is more firmly entrenched.

Second, some experts believe that investing in emerging markets can just as easily be done via those big multi-national companies in America and Europe which derive an increasing proportion of their sales in the developing world.

Again there is considerable merit in splitting your portfolio between both emerging and developed markets.


5. Passive or active?

We continue to see both actively-managed, stock-picking funds and passive or tracker funds in our lists of best-sellers. This makes sense. That’s because passive funds have some advantages over active funds (they can be cheaper and they are simple to understand) but some disadvantages too (simply buying every share in an index means an investor is guaranteed not to outperform that index and they will automatically have a higher exposure to the index’s biggest companies which may well not be the most attractive investments).

Passive funds are likely to be best suited to well-researched developed markets where gaining a competitive edge can be more difficult for fund managers while in less well-researched emerging markets, or when investing in smaller companies for example, an active approach is likely to be better.

6. Income or growth?

There are as many different investment styles as investors but these are often grouped into two broad approaches – income or growth. As the names suggest, the first type of investor focuses on the dividend income that companies pay to shareholders and tries to assess how reliable that income is and by how much it is likely to grow over time. Growth investors are more interested in how fast profits are likely to grow. Both approaches have their merits although growth investors have a tendency to be more optimistic by nature.

This can make growth funds more volatile than income funds where expectations for growth are lower so there is less room for disappointment. With income funds, dividends contribute the lion’s share of total returns over time. If you don’t need to take the income from a high-yielding share, reinvesting it can be a fantastic way to create capital appreciation. Again it can provide the best of both worlds.