It's ISA time. So will you go for safe or sexy?

With a month to go to the deadline for investing their annual £7,000 tax-free allowance, savers must ask how far they'll go in search of big returns

Jenne Mannion
Sunday 05 March 2006 01:00 GMT
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Use it or lose it. Every year, we are given a £7,000 annual allowance to invest in an individual savings account (ISA), where our money will grow tax-free.

With only a month to go before the end of the 2005-2006 tax year, time is running out. Miss the 5 April deadline and this year's allowance is gone.

It seems that more of us are catching on. This January, sales of equity ISA funds more than doubled to £82m compared to last year, says the Investment Management Association.

However, if you're among those yet to decide what to do with their ISA allowance, it can be daunting trying to work out where to start.

Do you, for example, want a solid but unspectacular mini cash account? The ones offered by Bradford & Bingley and the Halifax pay 5 per cent interest - and at least you know your capital is safe. Or would you like to chance your arm on the UK stock market through an equity ISA? Perhaps you are tempted by the billboard adverts - the posters, say, for the commercial property fund run by New Star. Or what about the "sexy" funds that invest in Brazil, Russia, India and China (known as Brics), available from managers such as Allianz?

Start off by working out your own attitude towards risk. "You must be realistic about your financial goals when choosing an ISA," says Andrew Graham of independent financial adviser (IFA) Allenbridge. "There's no such thing as a free lunch and you will only achieve spectacular returns by putting your capital at risk."

To pin down your attitude, consider if you can afford to lose the money invested. If not, a mini cash ISA is probably the best bet.

Cash investments could also suit if you're nearing retirement. As a rule, you shouldn't be reliant on growth in the stock markets at this point, as you will be exposed to the possibility of a massive downturn just when you need to get hold of your money.

However, those seeking greater returns than cash accounts can provide will need to look to other types of investment, such as stock market funds. Again, though, you will need to have a clear idea of the levels of risk involved.

For example, the FTSE 100 index rose by 22 per cent in 2005 - with many investment funds posting an even better return. But that hasn't always been the case, as Darius McDermott of IFA Chelsea Financial Services stresses: "In 2000, many 'low risk' investors didn't realise technology funds were high risk.

"They learnt the hard way when the dot-com and tech bubbles burst and these 'flavour of the month' investments plummeted."

Mr Graham says low-risk investors may find a bond fund appealing. Since some companies will default on their payments, corporate bonds aren't totally risk-free, but drastic falls in your investment are unlikely.

"There are many types of bond, ranging from government gilts to quality big companies, as well as lower-grade companies that pay out higher interest to compensate for being judged higher risk."

In particular, Mr Graham likes Henderson Strategic High Yield and Old Mutual Corporate Bond.

If you want higher returns, consider dabbling on the UK stock market.

A sound and relatively safe way to invest in British shares is through UK equity income funds that buy into companies paying dividends, says Mr Graham.

Most funds aim to yield more than 3 per cent, which means that even if stock market performance is flat, you should at least be getting some return. And if the market falls, the dividends should cushion the impact.

The top picks of IFA Chelsea Financial Services among UK equity income funds are Invesco, Jupiter and Rathbone.

Once you have a reasonable exposure to UK funds, look abroad to overseas stock markets. But make sure Britain forms the core of your portfolio, with international funds representing "satellite" holdings of no more than 40 per cent, says Mr Graham.

Mr McDermott is a fan of Artemis European Growth and Britannic Argonaut European Alpha, among funds that invest on the Continent. Among others he likes are JPM Japan, Legg Mason Japan and UBS US Equity.

If the idea of building your own portfolio and keeping tabs on it seems daunting, hand the task over to a professional by investing in a "fund of funds".

These vehicles, which tend to have higher overall costs for investors, put managers in charge of selecting a portfolio of underlying funds, and making asset-allocation decisions.

Both Mr McDermott and Mr Graham recommend the Jupiter Merlin fund.

Always take existing investments into account when determining how to use this year's allowance.

HOW TO INVEST: TIPS FOR OPENING AN ISA

You can invest up to £7,000 a year in an equity ISA. Alternatively, you can save up to £3,000 in cash and £4,000 in mini ISAs.

Consider going through a middle man as discount brokers use bulk buying to slash the cost of investing. Most funds charge an initial fee of around 5 per cent when customers buy direct; but brokers can get you the same funds for 2 per cent or less.

You can make monthly contributions instead of putting down lump sums, in order to smooth investment peaks and troughs. Most funds let you save from £50 a month, but some, such as M&G, allow £10 per month.

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