Is it better to use my ISA allowance on Stocks or Funds? and Why?

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12th Apr '17 by Narryjad

10 comments 9206 reads

Wondering if it is better to buy funds inside the wrapper instead of stocks. Any advice or suggestions would be welcome.

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Narryjad

Premium Member

10 comments

Antimidas

12th Apr '17

If you mean managed funds, then these mostly underperform stock indices (studies in US to March 2016 showed 82% underperformance over a ten year period compared to the benchmark), and charge high upfront and annual management fees for the privilege. Plus brokers charge an additional annual management fee for holding funds (and sometimes also stocks, depending on which broker and the size of your account). With Stockopedia, a bit of effort, and the right mental discipline, you should be able to beat the stock indices, incurring no management fees. So, whether your money is inside or outside a tax wrapper, stocks are the best choice. But if you are likely to be swayed by external factors like general news or the herd mentality (i.e. buying high when everything looks rosy, and selling low when news commentators are predicting disaster), or if you cannot dedicate sufficient time and effort, then funds may be a safer option.

Rusty2

12th Apr '17

You may want to consider dividends now these are taxed above £2,000 per annum, I think it makes sense to get the high yielding ones inside an ISA. Also high growth shares are better inside an ISA because of capital gains tax. Funds have some advantages, such as wide spread of shares and investing in countries that would be difficult to buy individual shares such as India and Vietnam for example, but as said above most don't beat the market. There were some small UK companies funds that have done well. If you are only just starting then funds maybe the best way to begin.

jonesj

12th Apr '17

We cannot give a definitive answer based on the evidence provided.
It depends on your tax rate, whatever other investments you make etc.

Examples:
1 The ISA has capital gains & dividend tax advantages. If you are investing so much that it cannot all fit within your ISA AND you regularly exceed your capital gains tax allownce, it might be better to put funds that you will hold long term OUTSIDE your ISA & have stocks which you make capital gains on within your ISA.

2 If you are a higher rate tax payer AND exceed the reduced dividend allowance AND buy stocks with a higher yield than your funds, this might also encourage purchase of stocks for your ISA. Or vice versa. To avoid tax on dividends.

There are other complications as well.

I try to operate as follows:
1 Any income with a 40% marginal tax rate is paid into my SIPP.
2 Below that threshold, I ensure the ISA is filled every year. Generally I try to put anything with a decent yield in the ISA for dividend tax relief.
3 I try to generate capital gains in the taxed account to make use of the annual capital gains tax exemption. However, if my holding in a particular stock is at the level where a capital gain in excess of the annual allowance could be generated, any further top up may be in the ISA or SIPP.

Incidentally, I hold stocks, investment trusts, etfs and no funds at all.
This is based on investment trusts charging less in fees than unit trusts, but since that is no longer always the case, I should review the policy when adding to those positions.

timarr

13th Apr '17

If you have a significant portfolio already (at least £100K) and you understand both risk and volatility and are comfortable with them then you should pick the combination of stocks and funds that gives you the risk profile you want to achieve.

If you don't know what the previous paragraph means you aren't ready to invest actively and you should invest in passive funds - i.e. index trackers or EFTs. You'll outperform most people investing actively in doing so.

You should probably aim to spread your allowance out over the year, in 12 monthly payments. You should also invest in a mix of indexes, don't simply invest in the UK. Look for international diversification. You should also look for asset class diversification but if you already own your own house avoid property funds, that's simply doubling up that bet.

timarr

AnonymousUser858

16th Apr '17

Most of us are not very good at picking stocks. That includes people who manage funds.

Most of us we are not very good at picking funds either. Which means that we are bad at picking funds which are themselves bad at picking stocks!!!

So for a new investor, just starting on the journey, it is rather difficult and fraught at the beginning.

I would recommend diversification (to reduce stock specific risk) by spreading your investment across a number of holdings as well as diversification (to reduce timing risk) by spreading your investment across time. ie drip your investment in over time.

I would also recommend Investment Trusts - closed ended funds - as distinct from open ended funds. IT's tend to have lower costs/fees and often trade at a discount to their underlying assets. A basket of ITs can provide good diversification and decent returns.

I have about 30% of my money in ITs and they are the ballast in my portfolio. Another 25% is in individual equities which are higher risk/return propositions.

If you want to learn more about IT's and get some ideas for selecting them, I'd recommend John Baron's portfolio website. I subscribe thereto and consider it good value. You can get a free trial sub.

samanddee

19th Apr '17

I tend to pick and mix now between funds, stocks and trusts (i've been investing for about 20 yrs).

I go with stocks where I feel comfortable I understand the story of a stock and where you think you've a rough idea where it will go longer term. For international exposure or say themed investments (think biotech etc) I tend to think it's an area I want exposure but don't have the skill set or inclination to scour the markets personally and I'm never really going to be in touch with those markets so it's worth paying someone to manage that for me so long as they do deliver.

The exception to this is the US where I am happy to invest directly in US companies as they are often companies that are clearly visible presence here for instance Mastercard, Visa, Costco etc as living here in the UK I've got visibility on the nature of these businesses just as if I lived in the US. Investing in US is generally fairly straightforward so why not.

For Asia, European, Emerging Markets for me it's trusts/funds I just don't have the time or inclination to invest huge time and I want to limit my total no. of investments generally to no more than 30 (stocks + trusts + funds combined). I want global exposure so for me this is the best way hence pick and mix.

One size never fits all but generally I prefer trusts to funds particularly where I'm investing lump sum and there is a healthy discount that seems not to be warranted with the current managers performance. Look at TRG for instance - great manager performance and a healthy discount? The Trusts will have done better recently in rising markets as they are geared so if you think the markets may retrace some of the recent gains perhaps a consideration for you.

When I kicked off investing years ago though I opted for funds as that worked for me drip feeding (that would have been v expensive with trusts). You could always consider setting up a virtual portfolio of stocks yourself and see how you do vs a good fund/trust in that sector. For sure ultimately it's stock pickers that tend to do the best think Buffet, J Slater and John Lee if you can avoid management fees it does compound tremendously over time. It's just a matter of whether you have the skill set to back winning stocks the majority of the time or not.

Given you've raised the question above though my suspicion would be to get some confidence first that you are sufficiently good at stock picking by monitoring your performance against say the FTSE100/250/all share with a portfolio reasonably well referenced to that market. If you can better the return of the market you are investing in perhaps the time and effort is worthwhile doing this for you. If you are doing so with a low risk then that is holy grail!

A lot of people say go with trackers it sounds like you are interested in shares at least with trusts you can start to understand the managers selections, insights etc. Trackers for sure have their place if your on this bulletin board your into the view that you might do better than this for yourself which many do.

Another point is trackers are gross market when I invest in funds / trusts I often go for smaller company type plays it's in these markets often things are mispriced as coverage is naturally diminished. Fingers crossed Paul's Revolution Bars turns into another Avesco.

As John Lee says it's like a round of golf if you can avoid a bad hole or two (think bad share) you should end with a good score. Hopefully a few of the stocks soar over time and you let success run.
Key is to cut losers quickly a lesson I learned very quickly when I lost 80% on one of the first shares I purchased a few years ago - touch wood not been repeated and whilst it hurts to sell on a loss it's part and parcel of the game. If you had a great race horse and a doddery pony you'd be putting your efforts in the thoroughbred yet with shares the mentality seems to be the opposite!

Investing in funds initially allowed me to slowly build enough capital to have enough to make a diverse enough stock portfolio when I did dip my toes finally into shares. I also had been involved in a share club for years which was a good learning.

There are lots of good bulletins on Stockopedia particularly Paul Scott. I'd also recommend Investors Chronicle it helps to get some idea what you might want to research.

A word of caution though is individual stocks do tend to require more attention and don't do a virtual portfolio to track 'your performance' if you really don't think you'd geniunely be invested in those companies in reality. Since dipping in stocks I keep a full tally on my portfolio performance vs. the market so I have a good understanding that I'm doing alright. Personally I've benchmarked off of the FTSE250 since it's tended to be the best performing market so I want to know I beat what I would have done if I'd just bought a tracker fund in it. Fingers crossed so far so good but its taken over 3 years to get a good idea of how 'my portfolio style is working and I tend to keep a ytd tally also ongoing just to ensure I'm doing ok at the moment in case markets start favouring a different style...

jonesj

19th Apr '17

Do you mean you are not sure whether to buy stocks or funds ? (Or for that master Investment trusts or ETFs).

Or have you already decided to buy both, but are not sure which goes in the tax exempt ISA & which goes in the taxed account ? (After of course using your annual ISA allowance).

My previous answer was based on the latter interpretation.

samanddee

19th Apr '17

I'd say the key is the one that Buffett comes too 'don't lose money' whilst there are ways and means of optimising tax efficiencies key is you're on a path to real profit - best ensure your on that +ve path first before optimising I reckon. If you make losses on a normal account those can be offset but not if held in an ISA for instance so for sure put the ones you expect to lose ex. ISA better still don't invest in things you expect you are going to lose on in my view (so far as you can). My preference is avoid jam tomorrow stocks which seldom come with yield and would naturally fit into using a CGT if the windfall was actually realised.

Many other saving factors though in addition to tax e.g. broker, stamp duty, amc, bid/spread etc - no one size fits all. Some of the fund supermarkets for instance charge also to hold funds but don't on trusts as they are 'stock'. There are a lot of factors but in the end the key is surely just to pick good stocks be sensible with allocations and exposure and monitor your performance to have some baseline and work out if the effort to get good returns is worth it. I'd not avoid paying tax on things outside tax efficient wrappers because it was a stable company paying a yield but you're right if I'd two stocks to place one in a wrapper and one outside I'd put the higher yielding share inside the wrapper.
I'm looking to buy some stock outside of the wrapper and I'm looking at TRG and Fidelity Asia Value as reasonable trusts that don't pay high yields but hopefully should use some of my CGT allowance.

Edward Croft

20th Apr '17

It rather depends on your situation. I'm biased but I would always vote for 100% in stocks... unless:

You have very little capital.
You seek foreign diversification in a simple collective investment wrapper.

Stocks provide direct ownership, you also can access far higher rates of return by building a human-scale portfolio than eating the institutional-scale portfolios delivered by fund management houses. Also - buying stocks is just a heck of a lot more educational and more fun ?

I did put this piece/spreadsheet together previously titled "When does it pay to be your own fund manager?" - worth reading.

GrahamF

20th Apr '17

I would start by considering your asset allocation i.e. asset class (equities, property, commodities, fixed interest, alternatives, etc), geographical spread, capitalisation spread. The adage don't put all your eggs in one basket is especially good advice in times of uncertainty and we are definitely in uncertain times so assigning your investments to a mix of assets is a good idea.

Having decided your asset allocation, then you can decide the best way to access that market - funds, ITs, ETFs, ETCs, or direct ownership of shares.

You cannot be a specialist in everything. So, mix and match. Where you think you may have the skills to pick your own stocks do so, and see if you can beat the indexes consistently, but choose a range of professionals to do the rest.

A lot of people will say that because very few professional fund managers can beat the market consistently don't use them. I would ask the question, you wouldn't hold onto an under-performing share so why would you hold onto an under-performing manager? In other words, be as coldly logically about changing fund managers as you would selling shares and you can fairly easily choose a portfolio of managers who will give better than index returns. But where a market is very efficient and very few managers beat the index for more than a couple of years at a time, consider ETFs or trackers - but be aware that you need to jump in and trade if a sudden event will impact negatively on the index.

As has been pointed out, take care not to incur excessive costs. Platform costs and ongoing charges costs for funds etc have come down, but there is still considerable difference between their costs based on how frequently you trade, portfolio charge based on size or flat fee etc. So, choose wisely to fit your situation.

One other issue to consider is CGT. If you are likely to overshoot your CGT allowance then consider that a fund manager can change the composition of a fund without it triggering a capital gain, whereas if you hold shares directly the transaction will need to be inside an ISA or SIPP etc to be free of CGT if you have used up your CGT allowance.

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Is it better to use my ISA allowance on Stocks or Funds? and Why?

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Narryjad

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