Which is the best stocks and shares ISA for me, you may ask. Everyone is telling you to open yourself one, but which is the one that will fit you like a tailor-made suit?
From this post, you will learn how to select the ISA that best suits your needs. Because the one for you is not the best on offer, but the one that best fits your situation. ISAs are still a good investment because of the tax benefits they offer – let us remember that it is a tax-free wrap around many traditional, alternative investments and cash and it is still your best bet for a prosperous future.
Deciding which is the account for you is a bit like trying to decide which is the best precious stone in Aladdin’s cave – there is so much choice and competition, it is overwhelming.
Of course, you may decide to search the Internet, but this comes with its issues – this search is far too broad, and you must know enough about the types to specify it. You may specify your search and look for the top returning fixed rate ISAs in 2020. Still, how do you decide between a return of 12% and a return of 2.1%?
Here is the thing: we are talking about your wealth, your savings, your investments. And your task is to select ‘the best ISA for you’.
When I select the type, account, and provider for me, I ask myself the four questions below. Once I have answered them, I use the ‘best ISA for me’ selection rule you can find in the penultimate section of this post.
What is the potential loss?
When looking at the potential losses of an ISA account, you must pay attention to two kinds of loss:
- Potential losses because of the investments wrapped in your ISA; and
- Potential losses due to trouble with the provider.
Let’s tackle the second kind of loss first. Companies can go bust, and ISA providers are not exempt. Hence, it is vital to ensure your provider is covered by the financial conduct authority (FCA). You can choose to open accounts that are not covered by the FCA, but you must be aware of the risk – if the provider goes into administration, you may lose all your money.
It is a bit more complicated when it comes to working out the potential losses because of the investments, or savings, you’ve wrapped in an ISA. Here is what to expect as a level of potential (apparent) level of loss with different types:
|Cash ISA||Stocks and Shares ISA||Innovative Finance ISA|
|Low||Medium to High||High|
A word of caution:
- As a rule, cash ISAs come with a, what appears to be, low level of loss. Still, when the rate of inflation is higher than the interest offered by these accounts, you may find you are losing money faster than water goes through a sieve. Please consider whether your desire to avoid risk is sufficient to offset the certainty of continuous loss.
- Stocks and shares ISAs can be vastly different according to the potential loss they carry, depending on whether these are individual shares, ETFs, index funds, or bonds.
- Innovative finance ISAs, usually offered by P-2-P landers and business adventurers (like investing in prospecting for gold in Africa), comes with a high potential level of risk because they are mostly not FCA covered.
Analyse ISAs with these risks in mind. To select the appropriate one for you, you must also ask yourself what your level of risk tolerance is – never choose one with a potential loss that is far above your personal loss tolerance level. You will end up getting out of it when you shouldn’t, like right now.
(A good thing to remember is that a drop of the stock market of up to 10% happens several times a year and recovers within weeks; a decline of 40% or over occurs every five years or so and recovers within eighteen months.)
What are the ISA account fees?
Usually, I’d say that you must watch the tax and fees, but ISA is tax-free so…Let’s focus on costs.
Generally, the lower the fee, the better for you. When you are working out how much is the fee, look for the things that are not immediately obvious – most providers split the charge between management fee, trading fee, and the cost of the spread.
A small increase in fees can affect your investments rather severely in the long run.
What is the potential gain?
To work this out, you’d best check out the potential returns that the providers have achieved historically. Most providers are open, even vocal, about their past performance.
And remember, past performance is not a guarantee for future returns, and there is always a risk.
Is your account appropriately diversified?
Is it possible that diversification is not ‘proper’? – you may ask.
Lately, diversification can go wrong. You may find many ISAs that appear diversified on the surface are uniform because they use the same ETFs, Index funds, etc.
It is always worth ensuring your portfolio is diversified.
There is a trick to diversifying your portfolio – contribute to different types of accounts (the rules allow you to contribute to one cash, one stock and shares, and one Innovative Finance ISA within a tax year).
The ‘best Stocks and Shares ISA for me’ rule:
Best stocks and shares ISA for me = Acceptable risk level + low fees + high (potential) returns + high diversification
When selecting an ISA, you must ask yourself which is the ‘best ISA for me’.
Selecting the best one for you depends on your:
- loss tolerance;
- research of potential loss;
- knowledge of all fees;
- information on historical returns; and
- appropriate diversification.
You already know the ‘Best ISA for Me’ rule – use it.
You have until the beginning of next April to use your tax-free contribution of £20,000 per personal tax year.