Be wiser about an ISA

Beware the mating calls of those alluring financial advisers

If Martians landed in the UK in March or early April, one could forgive them for concluding that it was the mating season for birds as well as the sub-category of Homo sapiens known as financial advisers.

If Martians landed in the UK in March or early April, one could forgive them for concluding that it was the mating season for birds as well as the sub-category of Homo sapiens known as financial advisers. While the feathered species use song and plumage to attract mates, the advisers use the lures of tax-free, invest and Isa, verbally and in print.

It's the open season for the great tax-free bonanza. The nation's financial sector has been gearing itself up for months. Rain forests have been felled to provide tons of paper for promotional campaigns. This year the attempts of financial advisers to attract clients have been frustrated. The stock market has fallen out of bed and the word invest is about as appealing as limp lettuce in a salad. The advisers' claims of past performance have a hollow ring.

Recent events in the financial markets have emphasised that investing in the stock market is not without risk. On 5 April 2000 the FTSE 100 closed at 6379.31. This is a long way from last night's close.

But do not take out an investment purely because of the magical words "tax free". Always ask yourself: "Would I make this investment if the tax breaks were not there?" If you would, that is fine. If not, re-examine your initial impulse. It is unlikely any taxpayer would say no to investing in a cash Isa, because this is a basic savings account with a tax-free wrapper.

The problem is that Isas are complex products. Peps and Tessas were far simpler ­ the former was for stocks and shares and the latter for savings. Isas are a combination of the two, and wrap-round deposits, life products and stock market investments in one apparently seamless package. The edges can become blurred.

When one elderly relative, who is risk-averse, asked whether he should put some money into an Isa, I recommended £3,000 in a cash Isa and supplied the rates offered by a selection of providers. When we next spoke, he gleefully told me not only had he got a cash Isa but "a big one as well".

I asked what he had invested in. "I don't know," he said. "Oh, she was ever such a nice girl. The big Isa she recommended has paid out 20 per cent in the past 12 months. She had one, so she was putting her money where her mouth was."

He was happy and I saw no point in alarming him that he had unwittingly made his first stock market investment at the age of 80. If he loses money, or even knows he has, pride would stop him from revealing that.

The stock market is not for the faint-hearted. It will be no comfort to know your money is sheltered from the taxman if you lay awake at night worrying about the progress of your investment. Financial literature always refers to reducing the risk of investing in the stock market by placing funds in unit trusts or OEICs as these invest in a broad portfolio of shares. This is less risky than direct investment in a handful of shares, but if the markets plummet, the price of investment funds do likewise. The tax benefits of sheltering shares or equity based investment funds in an Isa are also not as great as many investors believe. Where dividends are concerned, a basic-rate taxpayer will save £4 a year in income for every £1,000 invested. Charges of merely 0.4 per cent will wipe this out. True, any capital appreciation is shielded from capital gains tax (CGT). But as each person's annual exemption for CGT is £7,500, those with modest portfolios can sidestep it. Married couples can transfer assets between themselves without triggering the tax. Their joint annual CGT exemption is therefore £15,000.

There is no doubt everyone who has the means should have a cash Isa. If your objective is to accumulate capital over time, and fluctuations in the market will not cause concern, an Isa where the underlying investments are equities should be your choice.