Stocks and shares ISA risks

If you're thinking of opening a stocks and shares ISA, make sure you understand the risks and how to manage them.

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Ceri Stanaway
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Saving into any kind of ISA has a major perk, in that any returns you make will be tax-free. But just because your money is held in an ISA doesn’t automatically make it “safe”. Stocks and shares ISAs carry exactly the same risks as any other type of investment. This includes the risk of your investments falling in value, particularly in the short term. The good news is that there are plenty of ways to manage risks and maximise the chance you’ll end up quids in.

Is my money safe if I invest in a stocks and shares ISA?

No matter where you keep your money, there’s no such thing as 100% safe. Even savings kept in cash under your mattress could be stolen, or wiped out in a house fire. And that’s before we even get started on the inflation risk of keeping all your money in cash. This is where the face value of money stays the same but its buying power declines as the cost of goods and services rises.

That said, different ways of saving carry different types of risks. Typically, the higher the risk, the higher the potential reward. Investing – including in a stocks and shares ISA – typically offers the potential for higher rewards than putting money in a cash savings account (including a cash ISA). So it stands to reason that it also puts your money at more risk.

What are the risks of investing in a stocks and shares ISA?

There are 2 main categories of risk you’ll face if you invest in a stocks and shares ISA:

  • Investment risk – effectively, the risk that your investments won’t perform as well as you expect, and could even fall in value
  • The risk that your ISA provider will go bust

We’ll delve into each of these in the rest of this guide, starting with the risk of your ISA provider collapsing.

Is my money protected if my ISA provider goes bust?

The risk of a financial provider failing isn’t unique to stocks and shares ISAs. It can, and has, happened to financial providers of many kinds. These have included plenty of smaller providers, but also (rarely) some big high-street names. One of the most famous of these was UK bank Northern Rock, which failed in 2007 and had to be taken into public ownership by the government in 2008.

Fortunately, such catastrophic failures are pretty rare. And if a regulated UK ISA provider were to fail, all or most of your savings or investments should be protected by the Financial Services Compensation Scheme (FSCS). For firms failing after 1 April 2019, this protects customer assets up to £85,000 per individual, per firm. Be aware that the FSCS only offers protection in the event of a financial firm failing. It doesn’t protect against the risk that the value of your investments may fall due to poor market performance.

What is investment risk?

Investment risk is the chance that your returns on an investment will be lower than expected, including the risk that you may lose money.

This risk applies to all forms of investment, including a stocks and shares ISA.

Of course, you don’t invest in the expectation that you will lose money. The idea is that your chosen investments will perform well and grow in value over time. But investment markets can be impacted by a range of factors. Some are unique to individual companies (if they’re poorly managed, or if initial appetite for what a firm is producing or selling wanes over time, for example). Others can affect large swathes of a market (including political upheaval, or global events that affect supply and demand).

Regardless of the reason, the reality is that financial markets can be volatile. This means that the value of investments can fall as well as rise, particularly in the short term. This is a risk you choose to take when you decide to invest in a stocks and shares ISA. In exchange, you’ll have the potential for higher returns than you’d get from a cash ISA.

A couple of pieces of good news though. Firstly, you can choose how much risk you want to take. And secondly, provided you are willing and able to invest for the long term (at least 5 years), in most cases your investments should ride out any temporary downturns.

How can I manage the investment risk of a stocks and shares ISA?

There are 3 main ways in which you can manage and mitigate how much risk you take with your stocks and shares ISA.

1. Choose lower-risk investments

While investing in general is riskier than cash savings, there is a sliding scale of risk. For example, investing in a fund – which comprises small slices of lots of different assets – is typically regarded as less risky than investing directly in individual stocks and shares. We outline some of the main investment types, many of which you can invest in through a stocks and shares ISA, in our introduction to investment risk. However, with greater risk comes the potential for greater reward. Opting only for lower-risk investments may limit the size of this potential. If you’re up for taking a bit more risk in exchange for higher reward, this is where tips 2 and 3 can come in.

2. Diversify your stocks and shares ISA portfolio

You can do this by purchasing different investment types, such as government bonds, corporate bonds, equities (stocks and shares) and funds – such as exchange-traded funds (ETFs). Opting for investment assets in different sectors and geographies can also help. Even if, for convenience, you choose to invest only in funds, try to go for a mix of different fund types. For example, you might spread your ISA across a fund that tracks corporate bonds, another that tracks the FTSE 100 and another that tracks a completely different market.

3. Invest for the long term

The value of investments can and does go up and down in response to a range of market influences. A stocks and shares ISA is certainly not the right savings vessel for money you’ll need within the next year, or even the next 5 years. That’s because the value of your investments may drop in the short term and not have time to recover. So if you’re hoping to buy a new car in the next couple of years, it’s probably best to pop your money into the best cash ISA. If, on the other hand, you’re saving to send your 2-year-old to university, a stocks and shares ISA could be a good way to do so.

Bear in mind that some assets are more volatile than others, and can fluctuate significantly over very short periods. If you want to invest significant amounts into higher-risk assets, a time horizon well in excess of 5 years may be best.

Low-, medium- and high-risk stocks and shares ISAs: How do I choose?

If you want, you can select exactly what assets to buy within your stocks and shares ISAs. That way, you can choose the balance of lower to higher risk assets. But if you need some help working out what to invest in that suits your risk appetite, there are a few options.

The traditional approach is to get advice from a professional financial adviser. But paying for regulated financial advice can be pretty expensive, and may be overkill if you’re only putting a few hundred pounds into a stocks and shares ISA.

Alternatively, many investment platforms let you pick from a selection of ready-made portfolios for your ISA. You just pick the one that sounds like it suits you the best (cautious, balanced or adventurous, for example) and the provider will invest your money accordingly. Some are fairly inflexible about what you invest in, whereas others let you adjust the portfolio if there are elements you’re not keen on.

A final option is to use a robo advisor platform. Rather than choosing your own ready-made portfolio, a robo advisor will usually ask you a series of questions about your circumstances, goals and attitude to risk, and recommend a set of investments for you. All monitoring and management is dealt with on your behalf.

Are stocks and shares ISAs worth the risk?

Zoe Stabler

Finder expert Zoe Stabler answers

The answer to that depends on your personal circumstances and your reasons for investing.

We’re assuming in the first place that you don’t have a lot of expensive debt. If you do, your first priority should usually be to pay this back before thinking about investing.

If, on the other hand, you have a decent chunk of money that you want to put away for the future, it’s worth considering the best home for it. Cash savings are usually regarded as “safer” (though they’re not entirely risk-free). And it’s always a good idea to keep a few months worth of essential expenses in cash savings, in case you need them for an emergency, or become temporarily unable to earn for some reason.

But if you’re looking to save some money for longer-term goals, and are (reasonably) confident you won’t need it for a few years, then it could be worth opening a stocks and shares ISA. Sure, investments are inherently riskier than cash savings. But they also offer the potential to make your money work harder, so could mean you end up with a bigger pot when you eventually withdraw it. And don’t forget that any returns are tax-free, making a stocks and shares ISA one of the best ways to invest.

Pros and cons of stocks and shares ISAs

Pros

  • Over several years, stocks and shares ISAs will usually offer higher returns than cash ISAs
  • You can choose the risk level of the investments in your stocks and shares ISA
  • Funds in stocks and shares ISAs are protected by the FSCS if the provider fails

Cons

  • Unlike cash savings with a set interest rate, the returns on investments are impossible to predict
  • As with any investment, your capital is at risk in a stocks and shares ISA
  • If you may need your money within 5 years, a stocks and shares ISA is unlikely to be the right choice

Bottom line

Stocks and shares ISAs can be a great way to save for medium- or long-term goals, and will usually deliver better returns than cash ISAs over several years. But in exchange for higher reward, you’ll need to be willing to accept a certain level of risk. Use the tips in this guide to understand how to mitigate that risk, and seek financial advice if necessary.

Frequently asked questions

  1. FSCS

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