Is it time to transfer your cash ISA into stocks and shares?
Following the Bank of England’s decision to cut interest rates to a record low of 0.25% last month, advisory and investment firm Hargreaves Lansdown reported a 50% surge in the number of savers transferring from a cash ISA to a stocks and shares ISA.
If you’re fed up with diminishing interest rates on your ordinary savings products, here’s all you need to know as you take your first steps into the world of stocks and shares ISAs.
What are stocks and shares ISAs?
Stocks and shares ISAs are investment-based savings products, therefore they’re riskier than cash products. You can invest in shares of companies or funds or investment trusts – pooled investment products run by a fund manager.
Why should I consider transferring to a stocks and shares ISA?
Apart from the historic low record rates which means record low saving rates, investing in the stock market, particularly over the long-term, offers a higher probability of outperforming cash.
Calculations from Fidelity International reveal that an investment of £15,000 into the FTSE All-Share Index 20 years ago would give you total holdings worth £55,105 today. If, however, you’d saved the £15,000 in an ordinary cash account over the same period, you would be left with a paltry £20,100.
Tom Stevenson, investment director for personal investing at Fidelity International, says the difference of £35,005 is “far too big for anyone to ignore.”
For the current tax year – 6 April 2016 to 5 April 2017 – the ISA allowance (the total amount that you can save each year) is set at £15,240. When you invest in a stocks and shares ISA, the allowance is based on the amount that you pay in, not on your returns.
As an example, if you contribute £12,000 into a stocks and shares ISA and after six months, the value stands at £16,000 which is above the annual allowance, you can still put in another £3,240 by the end of the tax year.
Further, stocks and shares ISA benefit from pound cost averaging which means that you can buy more shares when the price is low and less when the price is high.
If you’re still not sure you want to fully commit to a stocks and share ISA, then current rules allow you to have a cash ISA, a stocks and shares ISA, or both. You can put your whole ISA allowance into either a cash or stocks and shares ISA, or you can split it any way you choose between the two, as long as you don’t go over the £15,240 contribution allowance.
Some ISA providers may impose restrictions of their own in terms of whether you can transfer previous years ISAs or whole or part amounts so it’s best to check with the gaining provider.
One other important point to note is that saving in an ISA, no matter which form, means that your gains are exempt from Capital Gains Tax.
That all sounds good but what do I need to watch out for?
Transferring from cash to stocks and shares ISA means you’re moving from savings to investments and therefore taking more risk in the pursuit of better returns.
When you save money in a UK bank, building society or credit union, the first £75,000 is protected by the Financial Services Compensation Scheme (FSCS). But for investments, up to £50,000 per person per firm is covered for a valid claim.
And a big change from an ordinary savings account it that money invested in the stock market may fall as well as rise in value. Danny Cox, chartered financial planner at Hargreaves Lansdown, says: “This means you could get back less than you transferred. However, the longer you invest, the better the probability your stocks and shares ISA will give you a better return than cash ISA.”
If you’re ready to make the move, never withdraw any existing money as you’ll lose the tax-free wrapper; transfer it instead.
Lisa Caplan, head of financial advice at online investment management service Nutmeg, says: “Usually you ask your new ISA provider to contact your existing provider to request transfer of the funds for you. The steps you need to take depend entirely on your current and future ISA provider – generally, the website of your target stocks and shares ISA provider will tell you how to start, and most of the time it’ll manage the process for you.”
If you currently have a fixed-term cash ISA, there will be restrictions on transferring the product.
Any top tips on strategy or where to start?
Richard Stone, chief executive of The Share Centre, says the first thing you need to contemplate is your investment objective: “What are you saving for, and how much risk are you prepared to take with your money? You don’t have to put in a large capital sum at the start, you can drip feed into the ISA with monthly contributions and benefit from pound cost averaging.”
He says the strategy you follow for choosing your investments depends on how much time you have. “For a first time investor, we would recommend something along the lines of a tracker that aims to replicate the FTSE All-Share index. If you have more time you could build your own diverse portfolio by introducing individual equities alongside a fund or investment trust.”
However, he cautions that with this approach you will need to do a little more research to make sure you are not overexposing your portfolio to a particular sector or region, or allowing any one individual company to become a significant proportion of the overall portfolio.
Fidelity supports this strategy, saying the best protection against market uncertainty is diversification. Stevenson says investors should take a long-term view: “Volatility is the price that equity investors pay for long-term outperformance. Investing should ultimately be a long-term game and investors should not be put off by short-term market jitters.”
He adds that reinvesting the income you receive from your investments increases the amount of money working for you over the longer term. This phenomenon is called compounding and means you will be generating earnings on top of previous earnings. Lastly, it’s important to review and rebalance your portfolio to ensure it continues to meet your needs.
Cox adds that equity income funds are also a popular choice for people transferring from cash to stocks, as they pay dividend income of 3.5% – 4%.