Early bird ISA investors catch an extra £12,000 over a decade

The benefits of investing your ISA allowance at the start of the tax year are significant. But regular monthly investment has its advantages too, explains Katie Binns.

Right now, as the end of the tax year on 5 April approaches, last-minute ISA investors will be umm-ing and ahh-ing about what to do with this year’s ISA allowance, while at the same time early birds will be waiting for next Wednesday to roll around so that they can immediately fill up next year’s ISA allowance. 

Of these two approaches, early bird investing generates extra returns.The reason is that every day you delay investing your ISA money, you are missing out on valuable investment growth in a tax-free environment. You can invest £20,000 thistax year, in a combination of cash, stocks and shares and peer-to-peer lending platforms, and your money will grow free of income tax and capital gains tax.

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Investing the maximum ISA allowance of £20,000 at the start of each tax year (6 April) would give you a portfolio worth £264,136 after 10 years, assuming a 5% return after charges.

This is £12,578 more than investors who choose to invest the same £20,000 at the end of each tax year, and effectively only have nine years’worth of growth: their portfolio would have grown to £251,558.

“Over 20 years the impact is even more stark,” says Myron Jobson, senior personal finance analyst at interactive investor. “Early bird ISA investors catch an extra £33,000 in this instance - a portfolio worth £694,385 rather than £661,319 if they generate a 5% return after charges.”

Don’t just look at the maths. Take inspiration from ii’s ISA millionaires: these master investors are almost twice as likely to fund their ISA early, with 47% of all subscriptions invested in the first three and a half weeks of the 2020-21 tax year, compared to 28% for all other ISA investors.

Investing early also gives you more time to research and reflect on your investment choices. You're less likely to fall into the trap of choosing an unwise last-minute investment or failing to invest at all and keeping the money in cash.

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If you can’t afford to be an early bird

Of course, not everyone can afford to be an early bird investor and max out their ISA allowance straight away. A sum of £20,000 is significant - even if you’re paid two or three times the average UK salary, you may well still struggle to stump up £20,000 at the start of the tax year.

Indeed, right now, with so many cost of living rises and huge uncertainty around energy bills later in the year, stumping up any kind of lump sum for an ISA may not be a priority.

A regular monthly investment that allows you to drip-feed money into an ISA may be more feasible, and has the advantage over paying in a big lump sum of tending to be lower risk. This is because drip-feeding means you avoid putting your lump sum in just before a market crash and seeing the whole lot lose value. You can also benefit from what is known as pound-cost averaging.

Say you invest £100 a month. In the first month, the share price of whatever you are investing in is £2.50, allowing you to buy 40 shares. If the share price has fallen to £2 the following month, your regular investment of £100 will now buy 50 shares, leaving you with 90 shares in total and feeling well-positioned when the share price rises. If the share price falls again, your monthly £100 will buy even more shares, and so on.

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However, if you purchase all your shares in one go with a lump sum of £1,200 (the same amount as someone investing £100 each month for a year), you will buy your shares at the price being levied at that time - let’s say £3 in an unlucky case - and be stuck with 400 shares with no potential to pick up more at a lower unit price.

In a volatile market, the average price per share tends to work out lower when you save regularly. In other words, it ‘smoothes out’the cost of investing. (It’s worth pointing out that in a rising market you’re better off as a lump sum investor at the start of the period – but without hindsight it’s hard to know where the market will head next!)

In any case, regular investing suits most investors, who may not have spare cash lump sums but who can allocate a sum from their monthly earnings.

Jobson says: “If you have cash to invest, your money will be in the market longer when it is put to work at the start of the tax year – and if markets are on your side you can benefit from a whole year of compounding returns. Regular investing by drip-feeding your investments monthly to help smooth out the unpredictable bumps in the market can be hugely beneficial overall for a portfolio.”