Investing in an Isa? Avoid these common behavioural mistakes
Just before the end of the tax year, there’s the usual Isa rush where banks offer their best rates to entice you to hand over your money.
Given that the returns are tax-free, it might seem like a no-brainer, and often, taking out an Isa will make sense. But it’s not necessarily always the case.
Let’s slow things down and think this through.
Fear of missing out
Isa season revolves around a well-known sales tactic from the behavioural toolkit: fear of missing out, or Fomo.
When it comes to Isas, the fear is that you won’t make the most of the tax benefits if you don’t invest before the end of the financial year. Indeed, providers usually tempt people in by saying “buy now or miss the juicy tax advantages”.
The problem with this is that people can end up making rushed decisions, when in reality, many savers could buy an Isa after the deadline and use next year’s allowance instead, without hitting the £20,000 threshold.
For those who have money sitting idly in a current account which they don’t immediately need, it may make sense to move it before the end of the tax year.
If not, there is no need to rush. Certainly don’t feel pressured into making a decision quickly.
Spoilt for Choice
Isa providers can be very convincing when trying to persuade savers to invest, but carefully consider your choices before taking the leap.
This is particularly important if subscribing to an Isa means diverting savings from other investments.
Make sure you are maximising any workplace pension opportunities before opening an Isa. Certainly don’t jump the gun by opening an Isa without first considering whether it suits your individual goals.
Weigh up the pros and cons, and be aware of the restrictions placed on some Isas. For example, you can incur penalties on Lifetime Isas by withdrawing money for anything except buying a property and retirement.
Buying an Isa is only part of taking a responsible approach to your finances. It does not remove the need for budgeting, and should be considered as one component in your wider financial plan.
Common traps
If buying an Isa is right for you, avoid falling into common investment traps, such as buying a popular fund without considering whether it fits in a balanced portfolio. Also avoid home bias, which is a tendency to invest too much in your home country.
Tracker funds are typically the most convenient way to avoid these traps.
Also, remember that investments work best when held for a long time, preferably over five years. So if you buy a stocks and shares Isa, commit for the long term.
Loss aversion
One thing we know about Isas is that many people do not buy them to take financial risk. This is known as loss aversion, where our actions are motivated by a fear of losing.
In the 2017-18 tax year, 72 per cent of accounts taken out were for Cash Isas, and only 26 per cent for Stocks and Shares Isas. People may have excellent reasons for keeping a large amount of money stashed away in Cash Isas. The problem is that having such a risk-averse attitude can actually be detrimental to your savings. If inflation is higher than your interest rate, your cash will actually be losing money in real terms.
Various studies have found that those on lower incomes are particularly risk averse. As a result, their savings will not grow as quickly compared to those on higher incomes.
So if you have enough spare cash, ramp up your risk by using an Isa to invest. Commit for over five years, buy a widely diversified portfolio of shares, and make your money work harder.