Transforming personal finance since 2011

#27 — Accounts you need to know about: Your ISA…

September 1st, 2017

By Andrew Craig

Reading time: ~ 6 minutes

The most important account for someone UK-based to succeed financially is a stocks and shares ISA…

If you really want to make giant strides with your financial situation you need to start saving some money from your income each month.

No matter what your view of the UK pension system, you can’t touch pension money until you are fifty-five at the earliest.

If you plan on building fun-money sooner than by the time you have grey hair then you will need to save and invest cash separately from any pension arrangements you have. When you see how much you can make doing this you will want to do it.

Start as soon as possible.

As you may have read elsewhere, if at all possible you should aim for at least 5%, preferably 10% of your salary after tax being automatically paid into your investment pot every month. Once you have set this up, you will very quickly adjust to your new financial reality.

After you get used to it and you start seeing your pot grow, you might even consider upping the percentage to 12% or even 15% but 5-10% is a good number to start with. The more you invest, the faster you will become truly wealthy.

Whatever you manage to save, the upside of doing so over time is life changing and, due to the fundamental mathematical laws of compound interest I highlighted in an earlier article, virtually guaranteed to make you a serious amount of money over time as long as you are doing the right thing with your money in the right kind of accounts.

As long as you are saving less than £1,270 per month you will be able to invest all of this money using an ISA wrapper (Individual Savings Account). Obviously this applies to the majority of people.

What is an ISA?

An ISA account is simply a type of investment account within which the government lets you invest a certain amount of money each year. Crucially, any gains you make on that money are not subject to tax.

You can open an ISA account with a very large number of different companies in the UK, for example with the main high street banks and with a number of more specialist organisations such as stockbroking firms.

To open an ISA account all you need to do is fill in a form or two and transfer some money into it, either a lump sum or a monthly payment. Most ISA providers will let you open an account with as little as £50-100 to begin with, some with even less.

Cash vs. Stocks and Shares ISAs

Crucially, there are two broad categories of ISA account you need to know about: The first is called a cash ISA. A cash ISA account is not that different from a current account. You open an account and put cash on deposit. The only difference is that you get a slightly higher interest rate, depending on who you open your cash ISA with and you do not have to pay tax on any interest you make.

A stocks and shares ISA is a slight misnomer in that it is simply a type of ISA account which enables you to invest any money in that account in a very wide variety of assets (if you have an account with a good quality provider). That is to say that you can buy products other than just stocks and shares such as bonds and commodities. You can also just keep your money in cash hence why I think the name “stocks and shares” is rather misleading.

You may be aware that I take a dim view of cash ISAs. With real inflation at the sort of levels it is at today you will be losing real wealth if you use a cash ISA product. The only beneficiary of a cash ISA product is the firm supplying it to you.

If you are to have any chance of making a real return on your money you need to open a stocks and shares ISA so that you have the flexibility to invest in things which have a chance of outperforming inflation and making you a real return. The crucial thing here is to make sure you open an ISA account and with one of the best providers in the UK market so that you get the flexibility you need to succeed at the lowest possible cost.

As you might imagine, over the years, I have spent a great deal of time looking at the various different ISA providers in the UK market and have personally had accounts with no less than eight of them. To my mind there are a few firms in the UK who are demonstrably better than the competition and two of the best are:

  1. TD Direct
  2. Hargreaves Lansdown

More recently, however, I have come to feel that Hargreaves has the edge. This is simply because, although they both offer access to an impressively wide range of shares and funds, at the time of writing, my first hand experience and that of several other people I know is that HL have better customers service.

I am keen to stress that we have no commercial relationship with either firm but I use HL myself. In my experience, they are quite literally one of the only companies in the UK doing anything (i.e. – as compared to your utility company, cable company, mobile provider and so on), where someone articulate and entirely capable of helping you answers the phone within a few rings. This is why I use them. I think it is an astonishing achievement given how quickly they have grown in recent years too.

Avoid the high street banks

I think it is worth noting explicitly that the high street banks tend to be a bad place to have an ISA.

The ideal ISA account will enable you to buy a massive range of shares or funds and ensure that you can do so at low cost.

If you open an ISA with any of the main high street banks you will generally only be able to choose from their limited range of in-house ISA funds. These tend to be expensive and limited in terms of what assets you can end up owning. This is another key reason why so many people have a negative view of investing. If the only ISA or other investment you have ever owned is a high-cost, low-performance product from a high street bank you are very likely to have seen very little happen to your money over the years and have a pretty dim view of investment generally.

It is for this reason that I strongly recommend you use one of the two firms above.

An example of how important the tax-free status of an ISA is:

The key thing about having an ISA is that you will not have to pay tax on the profits you make from any investments you make within that account. This is hugely beneficial to how quickly your money will grow.

As an example, I invested my 2010/2011 ISA in silver. I was lucky enough to sell my position for a 163% profit about eight months after my original purchase. This meant I had turned my original ISA allowance for that year of £10,200 into about £27,000. If I had done this outside of an ISA account, I would have owed the government nearly £5,000 worth of tax. Thanks to the ISA, I owed them no tax on those profits whatsoever.