Eight tips to become a savvy ISA investor

It may come as little surprise to learn that a whopping 22.2 million UK adults have an individual savings account (ISA).

The popular tax wrapper’s core appeal is that you pay no tax on any growth, interest, or dividends. This means that, other than your investment costs, you keep the lot. What’s more, you can get your hands on the money whenever you want.

• Learn with ii: Stocks & Shares ISA Explained | ISA Investment Ideas | Transfer an ISA to ii

A further benefit is that, while the annual ISA limit is £20,000, there’s no cap on what your investments can be worth. According to figures from HMRC, the average ISA saver has a pot of around £30,000, but more than 4,000 investors have become ISA millionaires, boasting an average fund of £1.4 million. The 50 top ISA investors are sitting on average pots of £8.5 million.

Although such mammoth sums may seem out of reach, becoming a successful ISA investor won’t happen overnight. Even those with seven-figure ISA portfolios had to start somewhere.

But before you start ploughing money away for your long-term future, first make sure you have an emergency fund equal to six months’ expenditure, consider paying off any short-term, high interest debt, and keep money back for immediate spend such as holidays or a new car.

Once you’ve got these in order, it’s time to start investing. Here are eight simple tips to help get your ISA in better shape.

1) Define your investing goals

Setting yourself a goal or target is important for two reasons. First, you become more likely to develop solid and consistent investing habits if you have something to work towards. And second, it will help you choose the right type of ISA.

As things stand, there are four ISAs to choose from: stocks and shares, cash, innovative finance, and lifetime. Choosing the wrong one can harm whether you find the success you’re looking for.

Put simply, unless you need the money within the next five years, a Stocks and Shares ISA might be a better bet than a Cash ISA as the potential for inflation-beating returns is greater.

If you’re under 40 and looking to use the money either to buy a first home or fund your retirement, then consider a Lifetime ISA. Contributions are restricted to £4,000 a year, and you can only pay until age 50, but attract a government top up of 25%.

2) Get started

Starting as soon as you can is one of the most important aspects of savvy ISA investing.

That’s because every year you put things off, the amount you must invest to reach your target jumps sharply. For instance, if you invested £500 a month into a Stocks and Shares ISA, assuming 5% annual returns your pot would grow to £205,000 in 20 years' time. However, if you waited just two years before investing, you would accrue a fund of £175,000, some £30,000 lower.

The big factor here is compound returns, which have the greatest impact over longer investment time frames.

• My first four years as an ISA investor
• ISA fund ideas for different ages and stages

This doesn’t mean you have to start your ISA with hefty amounts. As flagged above, key when investing for the long term is to build the habit over time. This might involve starting with something small and increasing sums when you can afford to.

3) Maximise your allowance where possible

The maximum ISA allowance may have been frozen at £20,000 since 2017-18, but it’s still far more generous than in years gone by, even after factoring in inflation. Couples can invest up to £40,000 every year and shelter anything they make or earn from the taxman.

Although only a fraction of investors have the financial muscle to max out their ISA allowance year-in-year-out, you should consider using as much as you can.

If you’ve built up funds in your current account, or recently pocketed a healthy work bonus, your ISA can be a smart home for at least some of those funds.

If you choose to invest regularly, it can be a good idea to review your monthly ISA contributions every year, nudging them up if you can - especially if you’ve had a pay rise, freeing up more disposable income.

4) Select investments that are right for you

It goes without saying that if you want to join the current crop of ISA millionaires, you’ll need to take some risk with your money.

But while it’s easy to follow trends and others’ behaviours when choosing where to invest, risk appetite is very much a personal affair.

Whether you prefer to keep things simple and invest in a handful of funds or investment trusts, or build your own diversified portfolio is a personal decision that will usually depend on your knowledge and experience.

When starting off, ii's ready-made model portfolios might serve you well, but as your wealth grows and you become savvier and more familiar with your preferred investing style, you may want choose your own holdings. This might include adding some single company stocks if you feel confident enough.

• ‘High risk? I don’t see it that way’: the investment secrets of an ISA millionaire
• ISA ideas: alternatives to the most-popular funds and trusts

The only right answer here is to select investments that you are comfortable with, diversify between different asset classes, sectors and geographies to spread your risk, and always keep your goals in mind. For instance, if you want to buy a house in five years’ time, investing heavily in smaller companies, which can offer outsized returns but equally heavy losses, might not be a sensible strategy. However, this approach can make sense if your goal is a decade or more away, as you have time to ride out the sharp ups and downs.

5) Review your portfolio regularly, but don’t overdo it

If certain parts of your portfolio are underperforming, the desire to sell out and invest somewhere else can be hard to resist. You may appreciate that investing is a long-term game, but equally want instant results, and naturally so. Seeing your investments lose value, especially early on, is never a comfortable feeling.

But constantly switching in and out of funds and investment trusts to find quick wins can often do more harm than good. It’s often better to pick a suitable investment strategy and portfolio mix for the outset and stick with it – perhaps changing things up every now and then when you see fit.

• Six tips to retire using your ISA investments
• 11 ways to invest your ISA like Warren Buffett

But by the same token, a bit of periodic fine tuning can serve you well. For example, if you started with a 60/40 portfolio of shares and bonds, respectively, but over time these weightings drift to 70/30, rebalancing back to your target allocation will ensure that your portfolio’s risk is right for you.

6) Keep your fees low

In the same way that tax can eat into your investment returns, charges can too. Simply put, the compound effect of charges over time can have a pernicious effect on what ends up in your pocket. As my recent article explains, paying 0.5% a year more in portfolio fees could wipe up to £100,000 off your pot over a 30-year time frame.

The two main costs to watch out for are platform fees and the annual management charges on your funds, ETFs, and investment trusts. That’s not to say you should swerve all investment options that are pricier than the average, but keeping a close eye on your total portfolio costs will reward you in the long run.

7) Bed and ISA before April if you can

If you don’t have surplus income or capital to max out this year’s ISA allowance, but have an existing share portfolio, then something called Bed & ISA can be a smart thing to do.

• ISA tips: around the world in eight funds and trusts
• SIPP or ISA: which should you prioritise?

Between now and 5 April, you can sell investment profits of £6,000 and not pay capital gains tax. By redirecting these gains into your ISA, you can shelter any future growth and income from the taxman.

As this allowance is ‘use it or lose it’ and is halving to £3,000 from the 2024-25 tax year onwards, it’s something worth considering.

8) Watch out for IHT

While ISAs shield your wealth from income tax and capital gains tax, you should still be wary of other taxes. If you’ve been shrewd and amassed a sizeable ISA portfolio, the dreaded inheritance tax (IHT) might catch you out.

On your death, any ISA holdings typically form part of your estate, which could see HMRC grab up to 40% of your portfolio.

One possible solution here is to invest some or all your portfolio in AIM shares, which, if qualifying and held for two years, can offer 100% protection from IHT. A note of caution here, though. Companies listed on AIM are smaller and subsequently more volatile, so you will need to be comfortable with the prospect of significant losses.

• AIM ISAs are 10 years old: these shares are the big winners
• The funds pros have personally invested in for Junior ISAs