Why You Shouldn’t Stop Planning Ahead, and Why You Should Top Up Your ISA Earlier in the Year

As is distressingly evident this year, investors and society often face major challenges. Yet there are some things that are within your control, particularly when thinking about your personal finances. For example, replenishing your ISA earlier in the year can have a significant impact on your savings over time.

More time to grow
The main benefit of an ISA is that you can shelter £20,000 a year from tax, or £40,000 for a couple. Yet when we invest, we also do so with the intention that our capital will grow. More time in the market means more potential for growth in a rising market.

In the following illustration we highlight the benefits of accumulating tax savings over time by using an ISA as opposed to a taxable general investment account (‘GIA’), as well as the additional growth potential from investing earlier rather than later.

We consider the potential projected outcomes at the end of five years when £20,000 is invested each year in the Netwealth Risk Level 6 portfolio, achieving our assumed average return. When investing with a GIA at a higher rate of tax – by investing at the start of each year instead of the end of each year – the portfolio benefits from compounded growth for a longer period of time and results in a higher ending value.

By using an ISA and sheltering the portfolio from taxation, the portfolio achieves even higher ending values with the best outcome from using an ISA and investing at the start of each year. Of course, there is no guarantee that stock markets will grow over any given period, but over the long term, they have proven to be one of the most effective ways to outperform inflation.

Benefits of starting early: Investment growth and tax savings over 5 years

Source: Netwealth
Assuming higher rate tax on income and capital gains and an average annual return of 4.5%. Please note that forward looking models are not a reliable indicator of future performance.

Minimise hassle
Gain peace of mind quicker and avoid the last-minute agitation of organising your finances at the end of the tax year – including niggling paperwork. Also, by replenishing your ISA sooner you are less likely to forget to check it off your to-do list.

Use it or lose it
When you do forget, there is no second chance. Your ISA allowance is not cumulative, so every year you must use it or forgo its benefit.

Avoid mistakes
When we are flustered, or in a hurry, we are more likely to allow behavioural biases to affect our investments. These biases occur because we prefer to take shortcuts when making decisions, so for example, we may be prone to herd behaviour, overconfidence or simply suffer from inertia.

Invest monthly
You may prefer to invest a lump sum at the start of the year but investing monthly is effective, too, if you don’t have the full amount to hand. This method captures the benefits of time for capital to grow and minimising hassle, but it also lets you use what is known as pound cost averaging. This averages the price you pay for an investment over time and helps to smooth out the effects of market volatility.

Deploy the wonders of compounding sooner
More time invested allows your returns to earn better returns – the key factor of compounding, which Albert Einstein reputedly labelled as the eighth wonder of the world. The sooner you allow your ISA wealth to compound the better.

Extra Netwealth benefits
You can also gain extra benefits if you are a Netwealth client. You can:

  • Reduce hassle further by automating your annual ISA top ups from your general investment account
  • Take advantage of lower fees which can make a remarkable impact to your investments over time

Naturally, the earlier in the year you top up your ISA the more time you have for the benefits to accrue. Yet even if a few months have passed you can still make a considerable difference to the value of your tax-free savings.

Please remember that when investing your capital is at risk.

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