So you’ve got an Stocks & Shares ISA or are thinking of opening one. It can be tempting to just crack on, build a portfolio of reasonable looking stocks and funds, and not put too much thought into what’s going on behind the scenes.
Did you know your ISA investments are probably still paying over the odds in tax? That’s because your investment choices play a large role in how much tax you ultimately pay.
You’re probably also paying over the odds in fees – particularly FX fees. Again, this can be easily avoided if you know how.
People are mismanaging their ISAs in all sorts of ways, including misunderstanding the £20k limit and even cutting their potential portfolio size in half due to dividend complacency.
In this article we’re looking at 6 common but critical mistakes people are making with their Stocks & Shares ISAs, along with what to do to avoid them!
If you’re looking for a new ISA provider, a great option for hands-off investors is to open an ISA with Nutmeg. Just deposit your money and Nutmeg does the rest for you – no investing knowledge required.
New customers who use this offer link will also get the first 6 months with ZERO management fees. If you’d rather manage your investments yourself, check out our hand-picked range of ‘do-it-yourself’ Stocks & Shares ISAs here.
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#1 – You Still Have To Pay Some Taxes
Let’s kick off with the elephant in the room; tax. It’s what ISAs are for, to make your money invisible to HMRC. But ISAs do not make your investments completely tax free. They do protect you from the main ones of capital gains tax and dividend income tax, so are important to have, BUT there are some sneaky taxes that are still able to creep in.
If you make yourself aware of these, then you can make better investing decisions about what you’re buying within your ISA.
If you’re buying UK shares you will be stung by a 0.5% stamp duty tax with every purchase. This is a transaction tax, so one way to limit the impact of this is to hold your shares for the long-term, instead of trading in and out of your position. If you’re buying and selling frequently, each time you BUY it’s another 0.5% hit to your returns. If you’re only making, say, 8% growth in a year, that’s a significant tax.
Another way around stamp duty is to buy some international stocks instead. But these attract other taxes, such as the dividend withholding tax.
Many countries including the US and most European countries impose this tax on your dividends, which is taken before you’ve even received them.
We use synthetic ETFs like the Invesco S&P 500 ETF (SPXP) to avoid US dividend withholding taxes, and if you’re buying US stocks directly these don’t attract stamp duty either. US stocks still attract sales taxes, the largest being the Section 31 Fee or SEC fee, but you might say this is negligible at just 0.00051%.
But all of the companies you are investing in are paying corporation tax. So, you can’t avoid all tax – you can just try to make decisions that limit it. Remember, tax is just ONE element of portfolio planning, as part of your overall consideration of Total Return.
#2 – A Global Approach Might Mean High Foreign Exchange (FX) Fees
We always say to take a global approach to investing, but there are ways to do this which have no FX fees, and other ways which can have quite nasty FX fees.
What you probably shouldn’t be doing is frequently trading international stocks, such as US stocks, in your ISA.
Freetrade charges a 0.45% FX fee on stocks listed in foreign currency, i.e. not in pounds. Hargreaves Lansdown charges 1%. Interactive Investor charges 1.5%. Trading 212 charges 0.15%.
For the full listing of how much each of the most popular platforms charge for FX and all other fees, follow the link to the table on the Best Investment Platforms page.
The way we get around FX fees is to buy the bulk of our portfolios in ETFs, which we make sure are listed in pounds. Regardless of an ETF’s quoted currency, the underlying stocks in it can be from anywhere; for instance, S&P 500 ETFs listed in pounds invest in the top 500 US companies without you being charged an FX fee.
Note, we’re currently only talking about FX fees – you’re still exposed to exchange rate risk.
If you want to frequently buy and sell US stocks, you shouldn’t have to change your behaviour just because of silly FX fees. The answer might be to use a specialist app like Stake, which is designed to trade US stocks from the UK and solves the FX problem.
With Stake, your pounds are converted to dollars once at the point that you deposit cash into the app, rather than every time you make a trade.
This should save you a fortune in FX fees if you trade frequently. The app has no trading fees either, so you can buy and sell US stocks to your heart’s content.
Stake have a sign up offer for those interested, where new users will be given a free stock worth up to $150 when you use this offer link.
Stake doesn’t offer ISAs, so you can have a Stake account for trading US stocks, as well as an ISA elsewhere for your other investments. Just make sure the FX benefit outweighs any possible tax hit.
#3 – Don’t Fall Foul Of Capital Gains Tax (CGT)
It’s possible that you also hold investments outside of your ISA. These will be liable for capital gains tax if they exceed the annual allowance, currently £12,300. There is a clever tax strategy called Bed & ISA which means you can use your capital gains allowance on non-ISA investments without having to sit out of the market for 30 days.
The strategy involves selling your non-ISA investments, and buying the same investments again but within your ISA. Normally you’d have to wait 30 days before you could buy the investment back, otherwise it doesn’t count as an official sale in the eyes of HMRC, but using an ISA dodges this rule.
Investors with a large position in a stock or fund might choose to sell part of it to realise gains up to the capital gains allowance limit, so they are benefitting from their annual tax-free allowance.
If you don’t use the CGT allowance, you lose it, and you might otherwise end up being stuck with a larger gain in the future that’s above the tax-free limit.
#4 – Don’t Stop At £20k
ISAs have a £20,000 deposit limit each tax year, but there’s no reason to let this number dictate your investment goals. There are other ways to avoid paying tax on your investments even after you’ve hit the £20k limit.
The first is to ensure you are using your whole family’s allowances. This includes your spouse, and maybe your kids.
Your spouse also has a £20,000 allowance, and each kid gets £9,000. An average 2 child household therefore qualifies for £58,000 a year of ISA allowances.
Beyond this, each adult gets a £12,300 capital gains allowance and just a £2,000 dividend allowance. Because the dividend allowance is much smaller, it makes sense to put all of your high-dividend stocks and funds in the ISA and allow your growth stocks to be the ones that fall outside of your ISA limit.
Assuming annual growth of 8% on your non-ISA investments, you’d need over £150k before it even became an issue, or £300k as a couple.
Beyond THIS, tax can be avoided on investments by using spread betting, which can be used like an unlimited ISA for long-term investing if you know what you’re doing.
So an ISA is only one tool in your tax-fighting arsenal. But do make sure you are using your full £20k allowance if you can – if you don’t use it each year, it’s gone.
#5 – Don’t Follow The Herd: Portfolio Balance Is Everything
All the free trading apps are geared towards individual stocks. So is the media – look at any finance news and it will be about how Apple has done this, or how Gamestop has done that.
Rarely will you hear that the MSCI World Total Return Index has climbed by 26% in the last year, even though it has.
You could be investing in an ETF that tracks this index, or a collection of ETFs like the offering on Nutmeg which tracks the world in a similar way, instead of messing around trying to beat the market by building a portfolio of trendy stocks.
Make sure your ISA investment platform offers the range of assets that you need. Have you considered if you want to invest in REITs, which hold commercial property? Some ISAs offer these, others don’t.
Or investment trusts like Scottish Mortgage, which have an excellent history of outperformance – again, some ISAs offers these, and some don’t.
Do you care about actively managed funds? You won’t find these on the free trading apps.
Whatever you invest in, you need to consider how everything in the ISA comes together to create a balance of risk, return, diversification and perhaps a little fun.
You can be too cautious by over-investing in bonds, just because many investing gurus say you should have a load in your portfolio. But in this age of super low interest rates should bonds really be in your portfolio? Is the 60/40 portfolio outdated?
Likewise, you can be too risky if you only invest in individual stocks, or if your stocks are all in similar industries.
Remember your Pokemon training: a team of Fire types is useless if you come up against a Blastoise. And a portfolio of tech stocks is useless if tech crashes.
“Don’t follow the herd” also means “switch off the news”. Making investment decisions around events like Brexit and Covid might be too short-term, unless you’re picking stocks with the intention of making short term gains.
#6 – Don’t Let Cash Fester In Your Account
Some investors might intentionally choose to hold some cash in their ISA to max out their £20k allowance, even if they are not yet ready to invest it. That’s not what we’re talking about here. That’s a smart strategy.
What you should avoid is allowing your ISA’s dividends to remain stagnating as cash while you’re trying to grow your wealth.
Many ISAs will have the option to reinvest your dividends automatically into the markets. Robo investors like Nutmeg will just do it for you as part of the service.
Reinvesting all dividends will let compounding get to work for you properly. You’re really shooting yourself in the foot if you’re withdrawing your dividends before you’re ready to live off them, as it massively hinders growth.
The difference between an 8% return with reinvested dividends and a 6% return without them is enormous over 30 years. Starting with £100k, it’s the difference between a £600k final portfolio and a £1.1m portfolio.
Are you using your ISA to its full potential? How much will you be paying into it this ISA year? Join the conversation in the comments below!
Written by Ben
Features image credit: Zastolskiy Victor/Shutterstock.com