What is a self select ISA?
Most people who put money into an investment ISA are happy to allow someone else - a fund manager - to choose their investments for them. For those who are new to investing or are too busy to manage their own investment portfolio, it can be reassuring to hand the day-to-day responsibility for your investments to someone else.
However, some people prefer to manage their own portfolio. For those who are sufficiently risk-aware and are prepared to accept the extra work that comes with managing their own funds, a Self Select ISA can offer real freedom of choice.
How does a self select ISA work?
A self select ISA essentially involves taking your existing ISA allowance and choosing either individual shares or a combination of funds to go in it. You can select from a number of investments, including managed funds such as unit trusts, open-ended investment companies (OEICs) and investment trusts, as well as individual equities, gilts and bonds. However, Alternative Investment Market (AIM) shares cannot be included in a self select ISA.
Advantages a self select ISA…
- As with a traditional investment ISA, any earnings will be free from capital gains tax. Dividends earned by shares are taxed at 10% but holding them within an ISA means no further tax to pay thereby protecting them from higher and additional rate tax. Any dividend income from shares held within an ISA also do not count towards your dividend allowance. So, if you're a higher rate taxpayer and you want to be in control of your own portfolio, a self select ISA can be a tax-efficient way to achieve this.
- You can avoid paying fees to managers - if you're interested in managing your own investments, why pay someone else to do it for you? Additionally, hiring a fund manager doesn't always mean you're guaranteed the best returns. A recent study found that over the past three years, at least 100 equity investment funds examined had underperformed more than 10%. To put it in black and white - last year, fund managers invested £9 billion and collected £133 million in fees (thisismoney.co.uk).
- A wide choice of investments can be held within the ISA wrapper - individual shares, standard unit trusts, investment trusts and exchange traded funds are all permitted. If you pay higher rate tax or above, it makes sense to hold some of your investments as part of your ISA allowance.
Disadvantages of a self select ISA…
- Choosing a self select ISA doesn't mean fees are history - while you might not be paying for fund managementper se, you are likely to be charged a management fee, the format of which will vary. You might pay a fixed amount per year, or a percentage of your total investment. Whenever you buy or sell shares, you'll also be charged a dealing fee. It's important to factor in all charges before you sign up for a self select ISA - for example, if you don't plan on making many changes to your investments, the dealing fee won't be an issue, but if you want the freedom to buy and sell frequently, this can become costly.
- If you're a basic rate taxpayer, you won't really gain any tax benefit by investing via a self select ISA. This is because you'll only be paying 10% income tax on your investments anyway, regardless of whether you hold these within an ISA.
- As with all stocks and shares ISAs, you need to be comfortable with the risk that you might lose money.
- You need to be aware that, in order to build a diverse portfolio, you need to invest in a variety of investments. Each of these will incur dealing charges as mentioned previously.
- Investments tend to pay off longer term, so you need to be prepared to tie up your cash for a decent period of time - ideally, at least a few years.
In summary - if you're planning to build a large portfolio of shares and are in the higher-rate tax band, then a self select ISA can offer a good balance of investment freedom and tax efficiency.