Often how you invest is as important as where you invest. Many investors know about the importance of using their ISA allowance but fewer think about using it early. If you’re serious about investing for the future, getting an early start can
make a real difference to your wealth.
Tax efficiency can add up over time
Using their ISA allowance each year has become second nature for many investors, but it’s worth remembering why it’s important. All investments held within an ISA are free from income tax and capital gains, which can make a tangible difference to your wealth.
It means, for example, if you hold a £20,000 investment paying 5% income in an ISA, as a 40% taxpayer, you’ll save around £400 over a year. That may not sound like a lot, but over the long-term that £400 can grow and earn its own dividends.
Over 25 years, it could add around £1,400 to your investment. And that’s just one year.
As the end of the tax year approaches, there will be the traditional stampede to use the ISA allowance by 5 April. In some ways, this makes perfect sense. ISAs operate on a use-it-or-lose-it basis. The generous £20,000 allowance doesn’t roll on from one
year to the next, so investors understandably try to make sure they use it before it expires.
Compounding, for longer
However, there are sound financial reasons to resolve to do this earlier in the new tax year. The first is simple maths: the earlier you invest, the longer you benefit from compound interest. If you invest at the start of the tax year, you could benefit
from an additional 12 months of capital growth and dividend payments. That additional growth is then compounded over the lifetime of your investment.
Investing at the start of the tax year can make a real difference
Analysis by Investors Chronicle looked at a portfolio of £20,000 invested each year in MSCI World Index at each of the start of the
tax year, end of the tax year and monthly – over the past 10 years. Investing at the start of the tax year leaves an investor with a pot of £356,353 after 10 years, while investing at the end leaves them with £329,316, a £27,037 difference. The monthly investing
approach would leave the investor with a sum of £344,633, mid-way between the two strategies.
If you’ve received a bonus, for example, or have more savings in cash than you need for emergencies and unexpected costs, the start of the new tax year could be a good time to invest some or all of that money.
Regular investing can help to manage risk
If starting early in the tax year can make a big difference to your wealth, it’s also worth making the case for regular investing. You may get the middle path, as shown above, but you may also have avoided some worry and effort. There’s no great science
to regular investing. It simply means putting an amount aside each month.
This helps to manage some of the market risk that comes with investing, the risk that you invest too much at the top of the market, just when share prices are at their most expensive. This is more common than you might think. Investors often become enthusiastic
about specific areas at specific times – it’s part of our human instinct to run with the herd. This was most notable during the ‘Dotcom’ boom, but the phenomenon has been seen throughout history.
Regular investing makes sure you invest at a variety of price points. Sometimes you’ll be investing when markets are lower and sometimes when they’re higher, but it tends to even out over time, an effect known as pound cost averaging. This takes the decision
making out of investing. You don’t have to decide whether it’s a good moment or not and then act; it just happens automatically. This can be a more relaxed approach to investing, good for your long-term wealth and wellbeing.
Pensions offer another route to long-term, regular investing. They are also tax efficient, with generous allowances, but come with restrictions. You can’t access your pension until age 55, rising to 57 in 2028.
It's always worth investing early. This year, resolve to invest early in the tax year rather than leaving it to the last minute. You’ll be making the most of the available tax benefits, something you might be grateful for in the long term.