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New rules are bringing a new look to ISAs, which makes it timely to remember their benefits. David Burrows considers the choices and potential open to investors

A major selling point of self-select ISAs is that they have as much appeal to high-net-worth individuals as they do to the novice with a couple of thousand to invest. The annual allowance may not seem much to shout about but, over time, substantial portfolios can build up and all out of the reach of the taxman!

Advisory

A few brokers offer an advisory service to self-select clients, and it is certainly worth considering expert advice given the substantial investment sums that can be involved. Someone who had made full use of the annual allowances from when ISAs were introduced (in 1999) might have a portfolio that could now be worth in excess of £100,000. When portfolios reach this sort of size it may be worth taking the next step and moving from an advisory service to a discretionary broker service.

Conversely, those with large investment portfolios under the stewardship of a discretionary broker may be keen to take the reins themselves. Some see this as a good way of learning the ropes but also a way of seeing if a discretionary broker is actually doing the job. If the client is up over 30% over three years but the broker is up only around 10% then questions will be asked.

In terms of steering clients on what they put in their portfolios, the advisory element can be extremely user-friendly. Some may prefer to phone to discuss a stock; others who are content to invest in large caps, can choose a website that contains buy, hold or sell recommendations on FTSE 100 stocks. Of course, with a self-select ISA, it is the customer’s decision at the end of the day, the provider just supplies the information.

Execution-only

Most self-select ISA providers offer a straight-forward execution-only service and, if truth be told, the advisory services on offer are very much based on one-way traffic – namely that the client has to contact the broker for a view on a stock. Brokers are not going to spend time contacting clients on portfolio weightings and asset allocation guidance. With only £7,000 to invest, advice offered is little more than broker recommendations. In reality self-select ISAs are all about individuals being able to tailor their portfolios to suit their own needs – mixing managed funds with individual shares, gilts, bonds and a string of other investments.

Some might question the wisdom of investing £7,000 in a self-select ISA and then having to monitor the portfolio when it would be far simpler to invest in a collective or multi-manager fund ISA which should, in theory, have already spread the investment risk across a broad number of sectors.

Self-select ISAs may not be ideal for everyone but some would argue that they have distinct benefits too, with their facility for mixing shares, with investment trusts and unit trusts, ETFs, gilts and bonds and so on. Also, those with only £7,000 to invest might do well to remember cash savings too. An investor who does not take advantage of the ability to mix shares with collective funds might as well just buy funds via a fund supermarket, where charges will be minimal. But if you do manage your self-select ISA well, you can tailor a portfolio that has exactly the make up you want – and you can change the portfolio when you want, rather than when a fund manager or broker decides.

Of course, the key to running a self-select ISA is keeping a constant eye on all the holdings on an ongoing basis. As has been pointed out, aside from knowing when to buy or dispose of stocks or funds, the investor must also take care to avoid duplicating individual shares in the holdings of collective funds within the ISA. If you buy shares in, you need to be aware if the funds you have invested in have exposure to the same companies. The objective is to spread risk by not being over-exposed to one sector, stock or region. Another way of reducing risk is by using stop losses on stocks to limit any potential downside.

Lukewarm on Reits

Another recent addition to ISA rules is the ability to put real estate investment trusts within an ISA. In case you don’t remember, Reits were the last-minute compromise offered by Gordon Brown when he did his U-turn on direct property investment within a Sipp. What Reits offer is a combination of commercial and residential property but within a collective fund. (Property funds have traditionally been just commercial property).

In theory Reits are a great addition to the self-select ISA investor’s options but in reality there has been little interest so far. However, perhaps sentiment and circumstances will change.

Certainly there are benefits to Reits. A shareholder in a listed British property company faces double tax: the company pays corporation tax on its property-related business activities, while the investor pays tax on dividends and capital gains. You can put Reits in an ISA wrapper, which means you won’t pay tax on capital gains or dividends.

Costs

Self-select ISAs are only really relevant if you wish to hold individual shares, because fund supermarkets allow you to mix and match funds from different providers within a single ISA wrapper, typically cutting initial fund charges to around 0%-0.5%.

Then again, self-select ISA providers do offer better deals than going direct to a fund house and then having to switch and incur charges on the way. And when it comes to share dealing s, self-select ISA investors should enjoy the same rates as any other trader.

In fact, most companies offer frequent-trader rates. However, you must look out for additional charges. Trading fees, management charges and charges for transfers out all enter the equation. Up-to-date fee comparisons should be checked.

New deal on ISAs

From 6 April 2008 Peps and ISAs will be merged. All existing Pep accounts will automatically become stocks and shares ISAs. This is a great opportunity to review old and perhaps redundant Peps. For the first time it will be possible to view all your Pep and ISA investments on one statement and to devise an investment strategy for them – a particular benefit to actively trading self-select ISA investors.

An equally significant development is the freedom to transfer cash ISAs into stocks and shares ISAs. This means an investor who has put £3,000 a year in a cash ISA over a number of years can move all or part of this into an equity ISA, which could come to close on £30,000 cash (including interest) available to invest in the stock market tax-free.

You could argue that this rule change has come at the worst possible time – a credit crunch, a US economy in turmoil and concerns in the UK over consumer debts and a housing crash.

However, the flip side is that now is arguably a great time to go into the market: with valuations depressed, what better way is there to take advantage of these stock-picking opportunities than via money that was previously tied up in a cash ISA?

Perhaps one factor that could inhibit investors is that they need to be sure in their own minds that they want to transfer to equities. This is because the Treasury in its infinite wisdom has decided that the switch can only work one way, so ISA investors can move from cash to equities but they can’t move from equities to cash: once you have made your move there is no return.

It has been pointed out that, while savers cannot go back into cash ISAs, there is a cash option of sorts but it is very short-term. Cash may be held temporarily in a Pep, or the ISA stocks and shares component, until an investment opportunity arises.

Essentially, any cash has to be held on the basis that it is to be used for qualifying investments and not just put there as a kind of tax-sheltered cash deposit. If the right circumstances come along, it could be worth moving money from a cash ISA to high-yielding bonds in a stocks and shares ISA.