Leanne Macardle

Leanne Macardle

Editor
Published: 06/12/2018

At a glance

  • Stocks & shares ISAs are also known as equity or investment ISAs.
  • These are a tax-efficient products that invest your funds in the stock market or into company shares.
  • You can transfer funds from a stocks & shares ISA to a cash ISA and vice versa.

What is a stocks & shares ISA?

A stocks & shares ISA, otherwise known as an equity ISA or investment ISA, is a tax-efficient way to invest in a wide range of funds and other stock market investments. Unlike cash ISAs, where savings are held in a bank or building society account, the stocks & shares version requires you to actively invest your money across your choice of funds in the stock market or directly into company shares. The majority of such accounts use collective investment funds.

With a stocks & shares ISA, you can invest in:

  • Stocks
  • Investment trusts
  • Open Ended Investment Companies (OEICs)
  • Unit trusts
  • Government bonds (Gilts)
  • Corporate bonds

 

While you can hold individual company shares in an equity ISA, most are fund-based ISAs, which will be run by an expert fund manager who will pool investors' money and decide which companies and assets to invest in. The type of investments they'll make will depend on the aims and objectives of the specific fund (i.e. whether it's for income or growth – see below), and investors can either receive a form of income during the term of their investment or wait until they cash in the investment.

So basically, a stocks & shares ISA isn't a kind of investment in itself. Instead, it's a tax-efficient wrapper that goes around your investment to shield you from capital gains tax and income tax. However, it's worth remembering that your ISA pot would form part of your estate on death, so could be subject to inheritance tax at that stage.

What's the difference between a cash ISA and an equity ISA?

The key difference between cash ISAs and investment/equity ISAs is that the cash version holds onto your cash and pays interest, while an equity ISA actively invests your money into different external funds or company shares for the potential of bigger returns. The returns come from a combination of an increase in the value of the fund due to increased share prices and dividend payments into the fund from the companies which the fund invests in.

A cash ISA is essentially the same as a traditional savings account, but without tax implications. With this form of tax-free saving, your deposits are held in a bank or building society account and are currently covered by the Financial Services Compensation Scheme (FSCS), at up to a maximum of £85,000 per person per individual banking licence, and your capital is guaranteed.

An equity ISA, however, is not a savings account and should be viewed more as an investment product. It's a higher risk home for your money with a chance you could lose some or all of your initial investment. It does however share the same level of protection under the FSCS, with investors being currently covered for up to £85,000.

It's also worth mentioning that unlike with a cash ISA, there are charges involved with equity ISAs. There will probably be charges for setting up the investment, for making a share trade, and, where applicable, charges for managing an investment fund. If you want to cash in your investment early, or transfer to another investment, there may be charges for this as well. That said, this is no different than if you were investing outside of an ISA.

The pros and cons of a fund-based equity ISA:

  • The potential for better returns than can be found with cash ISAs. 
  • The reduced risk when compared with trading individual stocks. With fund-based equity ISAs you're essentially still trading in the stock market, but unlike the direct route you're not buying shares of individual companies. By diversifying your investments, you're reducing risk while still getting the potential for better returns.
  • The simplicity and convenience. Because you're putting your investments in the hands of a fund manager, you can benefit from their level of expertise while removing the complexity of direct investments. There's no need to constantly monitor the market or be involved in the day-to-day management of your money – just choose the fund that suits your needs and they'll do the rest. However, you should make sure your funds are performing well and continue to meet your investment objectives. 
  • The increased risk. The very fact that your money is actively working for you adds a certain amount of risk to the investment. Unlike with fixed rate cash ISAs, there's no guarantee on the level of return you're going to get, so investors risk losing some or all of their initial investment. Anyone not comfortable with that should consider a cash ISA.
  • The long-term view. Equity ISAs are only suitable if you're willing to commit your money to an account for the longer term. Short-term investments won't have the same effect, as long-term investing offers the best scenario for growth, and while most funds can be sold at relatively short notice, this type of account won't be good for those who might need to dip into their savings.
  • The fund charges. Equity ISAs may be exempt from income and capital gains tax, but remember that these ISAs will usually charge various fees, such as an initial charge, annual management charge (AMC) or even performance-related charges, so always check the small print to see if the particular account is worth it.

How much can I invest?

In the year 2019/20 your ISA allowance is £20,000, which you can either split between a cash ISA, an Innovative Finance ISA and an equity ISA in any way you choose, or invest fully into an equity ISA (or one of the others). You can now also invest up to £4,000 of your annual allowance in a Lifetime ISA, and withdraw and replace funds you have invested in an ISA without the replacement funds being counted as part of your ISA allowance. However, this flexibility may not be appropriate for an equity ISA, as the money should be considered a longer-term investment.

Did you know?

You're now able to transfer any funds held in a stocks & shares ISA to a cash ISA, or vice versa, offering extra flexibility in how you choose to save.

Buying an equity ISA – before you get started

Equity ISAs are more complex than cash versions. There are a number of different products you can choose from and different funds you can invest in, but by asking yourself the following simple questions, the process of making a decision becomes more straightforward:

  • Can I afford to take a longer-term view towards investing? In other words, you shouldn't need to take money out of your ISA to buy everyday items or for emergencies.
  • What level of risk am I willing to take? People who can afford to lose some of their money and have the longest view on investing are generally willing to invest in riskier funds.
  • What am I looking for from my ISA? Some people want their ISA to provide them with additional income, while others simply look for the value of their ISA to grow.

Once you have answered these questions, it's time to think about the funds that are right for you.

Although a stocks & shares ISA can be a tax-efficient way to invest, it is an investment nonetheless. This means you would have to accept the risks associated with this. There are two main ways in which you could lose money:

  • Investments can fall as well as rise in value – you could come out with less than you originally invested.
  • Investments are longer-term undertakings (of at least five years). If you need to access your money in the early years you may well find that if the investment hasn't grown much, and after any initial set-up fees or access penalties are taken into account, you come out with less than you put in.

What is your goal?

Generally, investors have one of two goals – either to generate a regular income to supplement other payments (such as a pension), or to build a large value of investments for a particular use, i.e. a dream holiday or to send their child/grandchild to university. 

Generating income can be achieved by investing in income funds (denoted by the term 'Inc'). The fund manager will usually invest in assets that provide interest or dividends which will then be passed on to you as an income payment from the fund, or alternatively you can have this income paid back into your investment to buy more of that fund.

Generating growth can be achieved by investing in growth funds (also known as accumulation funds, denoted by the term 'Acc'). The fund manager will usually invest in assets that are expected to increase in value, perhaps through an increase in a company's share price or an increase in the price of commodities.

Once you have an idea of the sort of fund that will help you achieve your goals, you can start to research suitable funds.

The value of investment advice when choosing an investment ISA

Good investment advice can be invaluable. Speaking to an independent financial adviser can help you make the most of your ISA allowance and find the investment that's right for you. A financial adviser is required to take full account of your circumstances before making a recommendation and will be able to explain the risks that you are taking.

Later on, if it transpires that the advice you were given was unsuitable, you would have cause to complain. If you arranged the investment yourself, without advice, you'd have less cause to complain if things went wrong.

Understand the risks

Any investment comes with an element of risk, particularly those with the prospect of higher returns, and it's important for any potential investor to understand them.

Over time there could well be fluctuations in the value of an investment, with the total value and any income generated capable of going down as well as up, and as such in a volatile market some investors may get back less than they put in. Past performance should never be seen as an indicator of future returns.

 

Disclaimer: This is a basic guide to stocks & shares ISAs. It does not cover every circumstance and nor is it intended to be a source of advice. This information is aimed at customers within the UK. Tax treatment depends on your individual circumstances and may be subject to change. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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At a glance

  • Stocks & shares ISAs are also known as equity or investment ISAs.
  • These are a tax-efficient products that invest your funds in the stock market or into company shares.
  • You can transfer funds from a stocks & shares ISA to a cash ISA and vice versa.

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