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Using a Stocks and Shares ISA is a popular way for UK investors to limit their tax bills. I’m a big fan. The vast majority of my stock market portfolio’s sheltered within ISA wrappers.
However, simple errors can slow the wealth-building process. Let’s explore some potential ISA pitfalls and strategies to avoid them.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
1. It’s not all tax-free
A Stocks and Shares ISA’s most significant benefit is the tax-free treatment awarded to capital gains and dividends. Tax efficiency’s a crucial consideration since it’s an easy way to boost a investor’s total return.
But ISAs don’t eliminate HMRC from the picture entirely. When buying UK shares electronically, Stamp Duty Reserve Tax is still owed, even if those transactions happen via an ISA.
Investors pay 0.5% on each share purchase, usually administered by the broker as part of the transaction fee. For those who frequently buy and sell shares, stamp duty costs add up considerably over time.
That’s why I’m a long-term investor rather than a short-term trader. A buy-and-hold strategy with less incessant portfolio meddling has many advantages, and losing less money to tax is one of them.
2. Don’t waste dividends
Next, there’s passive income. Dividends, although never guaranteed, are precious things. Those sweet cash payouts are crucial for the total return of many FTSE 100 and FTSE 250 stocks.
For some particularly high-yield shares, the dividend’s often the core reason to own the stock. Some companies in this category that spring to mind are British American Tobacco, Legal & General, and M&G, which offer mammoth yields ranging from 7.8% to 9.2%!
It can be tempting to withdraw dividends from a Stocks and Shares ISA and spend them. But those who aren’t living off their portfolio income are missing a trick.
Reinvesting dividends can turbocharge a portfolio’s growth potential by accelerating compound returns. And keeping cash invested in an ISA means an investor’s maximising the tax-free benefits too.
3. Avoid an undiversified portfolio
Finally, keeping all your eggs in one basket can be very risky. However great an investor’s conviction in an individual company, black swan events and company-specific risks can destroy wealth rapidly. The unanticipated collapse of airline stocks during the pandemic is a good – if extreme — example.
Diversifying positions across different companies and sectors can mitigate these risks. Some stocks even offer a nice degree of instant portfolio diversification. One worth considering is Scottish Mortgage Investment Trust (LSE:SMT).
This FTSE 100-listed investment trust’s portfolio spans 96 companies in private and public markets. Growth stocks are the name of the game.
Notable positions include e-commerce giant Amazon, Elon Musk’s SpaceX, and TikTok’s owner, ByteDance. With global interest rates expected to fall and President Trump retreating on tariffs, I think Scottish Mortgage shares are well-placed to outperform as investor confidence returns. Many stocks it owns fare better when risk appetites rise.
Exposure to unlisted equities brings significant growth opportunities, but major risks too. They’re difficult to value and more illiquid than exchange-listed stocks, so this fund isn’t for faint-hearted investors. It’s a volatile investment.
I own Scottish Mortgage shares in my Stocks and Shares ISA, but I want broader market exposure than a select group of growth stocks. Notwithstanding that, it’s an important part of my diversified mix.
