Twelve days and counting to use your ISA

This year's ISA allowance must be used by 5 April. David Prosser explains the rules

Millions of savers have less than two weeks to use their individual savings account (ISA) allowance for the 2005-06 tax year, which ends on 5 April. Miss the deadline and you lose this year's allowance for good.

ISAs aren't investments in their own right. They are wrappers within which you can hold a wide variety of investments - ranging from cash to shares - to shelter any income or gains you earn on the assets from tax.

This year, you can invest up to £7,000 in a stocks and shares ISA, within which you can shelter individual shares and most unit and investment trusts. If you also want to invest up to £3,000 in a cash ISA (see story below right), your stocks and shares allowance falls to £4,000.

Britain's biggest fund managers are in the middle of a marketing drive to persuade investors to use their stocks and shares ISA allowances before it's too late. But never make an investment decision purely for tax reasons - stock market investments can fall as well as rise in value and no tax saving will compensate you for significant losses.

Stocks and shares ISA investors must be prepared to tie up their money for a period - three to five years at least, if you're considering corporate bond funds, say, or five years for any stock market investment. Other options include funds investing in commercial property, commodities and a range of specialist assets.

The biggest mistake most savers make, financial experts say, is choosing ISA investments without considering their savings in the round. It's easy to be swayed by the latest hot investment theme - whether it's hi-tech companies or property - or a fund with a very impressive performance record.

In fact, what investors should look for, says John Taylor of Standard Life, is a diversified portfolio of investments. Start with some basic, less risky holdings, concentrating on the UK, for example. With a base in place, you can be more adventurous and consider overseas funds, or more specialist investments.

"Asset allocation explains how a person's savings and investments are spread between different types of investment according to their attitude to risk in order to meet their long-term financial objectives," Taylor points out.

"In broad terms, this means that someone with a cautious or low attitude to risk might have most of their assets in cash deposits or lower-risk investments such as gilts, while someone with a bolder or higher approach to risk might see more of their money invested in equities."

Standard Life's research suggests just 15 per cent of savers know where their money is currently invested. So before you even think about this year's ISA allowance, write down the details of all your existing savings and investments. Once you have a picture of your current asset allocation, you can then start thinking about the next interesting investment opportunities.

To help you compile a possible shortlist of purchases for this year's ISA allowance, Save & Spend asked three investment experts to recommend three funds. Above right, they suggest funds for ISA savers considering low- or medium-risk investments - those still building their base. On page 14, the experts also suggest some riskier options.

How you buy your ISA can also make a long-term difference to the returns you earn. Don't forget about the impact of charges on your ISA investments, particularly now the tax breaks on offer are no longer so generous for savers who use their allowances to invest in the stock market.

Share dividends are automatically paid with basic-rate tax deducted - ISA savers used to be able to reclaim this money, but this is no longer the case. As a result, for basic-rate taxpayers, there is no income tax to save by using ISAs.

ISAs do still offer protection from Capital Gains Tax. There is an annual limit on the tax-free profits you can make on any investment - £8,500 in the current tax year - unless your money is held within an ISA, where no limit applies.

Even so, for some investors, it is possible that the charges paid for a stocks and shares ISA will outweigh the potential tax savings the shelters offer.

Fortunately, you can reduce the likelihood of being caught out in this way. If you're using your annual allowance to invest in a single fund, most managers don't charge extra to set up your holding within an ISA. But you can also avoid or reduce the initial fees most fund managers charge - up to 5.5 per cent - by investing through a discount broker such as Bestinvest, Chelsea Financial Services or Hargreaves Lansdown.

Online fund supermarkets, such as Fidelity's Funds Network, offer similar savings and can also be useful if you want to invest in more than one fund in any one year. The supermarket provides the ISA wrapper - typically at no cost - and you choose the combination of funds you want to hold within it.

Self-select ISAs, available from some fund supermarkets, as well as most stockbrokers, are for people who want to use their allowances to trade in individual shares.

One cheap option is Alliance Trust's Savings Select ISA, where you only pay dealing charges when you trade. If you choose a self-select ISA provider that charges administration fees, think about whether you're saving enough tax to justify the money. Higher-rate taxpayers and those likely to exceed their Capital Gains Tax allowances in the future will benefit most.

Check the small print on your cash ISA

If you're not using your full stocks and shares ISA allowance and you have any spare savings, open a cash ISA. These are identical to conventional bank or building society saving accounts, but all the interest you earn is tax-free. You can deposit up to £3,000 a year into a cash ISA.

There are two choices for cash ISA savers. While it makes sense to earn the best possible interest rate on your money, the top deals come with strings attached.

Currently, the highest-paying accounts - from Saffron Walden and Portman building societies, and Alliance & Leicester bank - offer between 5.2 and 5.3 per cent a year. But all three depend on introductory bonus interest to get them to the top of the "best buy" tables. Once these bonuses expire, typically after six months, you will need to transfer your money to a more generous account.

The cash ISA rules let you transfer money between accounts without losing any tax privileges. But there are sometimes charges for doing so which can cancel out the extra interest. The alternative, therefore, is to choose the cash ISA paying the highest straightforward rate with no small print. Currently, on the minimum opening balance of £1, that's Halifax Bank, paying 5 per cent a year, or Kent Reliance Building Society, with 4.96 per cent. If you have the full £3,000 with which to open an account, Bradford & Bingley pays 5 per cent a year.

Janet Cane, a savings analyst at Moneyfacts, says: "Consumers need to check the product terms and conditions carefully."

What the experts recommend for stocks and shares ISAs

PAUL ILOTT, BATES INVESTMENTS

Low-risk fund: Jupiter Merlin Income sits in the Investment Management Association's Cautious Managed sector, but Jupiter is prepared to take big bets on individual funds to make a blend of equity and fixed interest funds.

Medium-risk fund: Adrian Frost's Artemis Income fund offers something a bit different from many other UK equity income funds that tend to under-perform the FTSE All-Share Index in strong market conditions and out-perform it in poorer market conditions

ANDREW DENTON, CHELSEA FINANCIAL SERVICES

Low-risk fund: Jupiter Income. Anthony Nutt has had good consistent performance over the last five years. He had a particularly strong year last year particularly benefited by mergers and acquisitions.

Medium-risk fund: New Star Global Financials. Guy de Blonay's performance has been excellent on this fund. He has produced over 180 per cent, in the last three years, which has only been beaten by the resources and emerging market funds in the IMA's Specialist sector.

PAUL ILOTT, BATES INVESTMENTS

Low-risk fund: Invesco Perpetual Income - this might seem like an odd choice for a low risk fund as it is fully invested in equities, but there are several reasons why I would suggest this. Firstly equity income funds invest generally in UK based, profitable dividend paying companies. In addition the portfolio is fairly defensive in nature.

Medium-risk fund: Artemis Global Growth - this global fund is managed by Peter Saacke at Artemis using its "smartgarp" system. In the two years or so that it has been managed on this basis, the fund's performance has been excellent.

Artemis is one of the best fund managers around today - the way this is managed is different to the majority of their funds, but performance is just as strong.