Step 5: Picking the right account

What we’ll cover:

• How to pick an account suitable for your:
  • investment time horizon
  • investment goals
  • income and tax status

This step is quite easy but really important. There are three aspects to this step of the Investment Pathway:

1. Picking an account type
2. Picking an investment provider
3. Picking the types of investment within your account

Let’s start with account type. There are generally three types of account you can pick from, which are (drumroll please):

1. ISA (Individual Savings Account
2. Regular Investment Account
3. SIPP (Self Invested Pension Plan)

Account types set the rules for what you can and can’t do. Some have tax advantages over others depending on your circumstances. Each is explained in some detail below. Importantly, a single person can use one, two or all of these types of account depending on their objectives and how much money they plan to invest each financial year. Its worth carefully considering the type of account that best suits you, as years from now it might be the difference between needing to pay zero tax or thousands of pounds of tax that could have been avoided.

ISA (Individual Savings Account)

Pick this if you are investing for a goal that is nearer than your retirement. An ISA allows your investments to grow without incurring any capital gains tax liability. Note that we hope and plan to generate good long term capital gains, so avoiding the chances of owing tax is a really good thing! Remember though, you can only pay into one ISA account in any given tax year.

Regular Investment Account

Pick this (again) if you are:

The advantage of this type of account is that you are able to invest an unlimited amount as a one-off sum, or in total each month and year, but be warned that you may be required to pay tax on capital gains and dividend income. The tax disadvantages are why its almost always better to use an ISA for investments than a regular investment account.

SIPP (Self Invested Pension Plan)

A SIPP is a type of account that allows all the tax perks of saving into a pension, whilst allowing eager individuals like us to make their own decisions on what they invest in (unlike a company pension which usually makes these decisions for you). You are in complete control in a SIPP (as with an ISA or Regular Investment Account). BUT we are absolutely not discouraging contributing to a company pension (these are usually fantastic value for money due to your company (usually) contributing to your pension out of their own pocket in addition to your own contributions). Benefits like this through your work should always be investigated and taken advantage of if you can.

Pick a SIPP if you are investing for retirement or you are comfortable not being able to access your investments until this time. Currently, you have to be aged 55 or above before you can make withdrawals.

The main benefit of using a SIPP is that your contributions are effectively topped up by your marginal rate of income tax. This means that if you are a 20% tax payer, every £800 contributed would get topped up (courtesy of the government) to £1000 as if by magic. For higher rate tax payers who normally pay 40% income tax, they get this same top up, and are able to claim back another £200 through their tax return. This means that for every £1,000 invested it will have cost £800 for a basic rate taxpayer and £600 for a higher rate tax payer. For anybody able to make investments today and be confident they wont need to get at them before they turn 55, this tax relief makes SIPPs the best option.

Lastly, at the point when you start to withdraw money from a SIPP, the first 25% of the balance can be taken completely tax free, but the remainder is taxed using normal income tax rules depending on how much you take out each year.

What we do

We are primarily investing for (early) retirement, but like the flexibility of being able to access the investments earlier than age 55. We therefore invest using a combination of SIPPs and ISAs.

Okay, lets now tackle picking an investment provider. Investment providers are the companies that let you open an account with them so you can start investing. Most investment providers offer each of the above three account types, but some of them might not offer an ISA or SIPP. Watch out for this. There is no point registering with an investment provider if it doesn’t offer the type of account (or accounts) that is most suitable for your needs.

Investment providers typically offer you two types of investment can you are able to buy within your ISA, SIPP or Regular Investment Account:

• Funds – these are grouped investments. A fund manager buys and sells shares of individual companies on behalf of all the individual owners of the fund (e.g. people like you or I). The value of the fund moves up as the companies it owns shares in do well, or down when they perform poorly. Because a fund holds shares in lots of companies its less likely to be as volatile as holding shares in a single company.
• Shares in individual companies

Some also offer different ways of investing, e.g. CFDs, Spread Betting, Options, Forex trading, etc. These are complex, potentially very high risk and are out of the scope of what we are interested in at HowtoStartInvesting.co.uk.

The investment provider is usually the middle man that you interface with. They can be thought of like a supermarket. For example if you want to buy baked beans, you don’t buy them directly from Heinze, you go to a supermarket like Sainsbury’s and pick them off a shelf. An investment provider works in the same way; if you want to buy a fund from a company like Blackrock, you would normally buy it from an investment provider like Fidelity. Fidelity will also offer funds from lots of other companies too, so you can compare and contrast their merits before making your selection.

The main things to be aware of when picking an investment provider are:

• Each specialise in different areas. Some are better for investment funds, others are better for buying shares of individual companies.
• Each have different fee structures. Some will change flat monthly fees, others only charge if you are changing the investments in your account.
• Most charge a ‘service fee’ if you are holding funds with them. This is the charge they take for being the middle man between you and the fund provider.

If you will be primarily using the Invest Like Us plan, then you will want to make sure that you are minimising the commission (dealing) fees associated with buying shares in individual companies.

If you are primarily buying a portfolio of funds, then you will want to ensure you aren’t paying unnecessary transaction fees, and minimising the ‘service fee’ charged on your account balance each month or year. Its important to also be aware that each fund usually has its own management fee. These are paid in addition to the service fee.

Some investment providers specialise in offering a large choice of funds, whereas others don’t offer funds at all and exclusively only allow trades in individual company shares. There are companies that offer both, but this doesn’t necessarily mean they are good at both, and beware of higher fees.

Another pitfall to look out for is that some of the investment providers offer a reduced selection of company shares. This isn’t always obvious until you search for a specific company and find you can’t buy it!

Lastly, if you are interested in buying shares from non-UK markets (like the US), some investment providers don’t offer shares in foreign companies. The Invest Like Us plan is very much open to looking for opportunities with both UK and US based companies.

What we do

We use IG for buying shares within an ISA. We like their relatively low commission, their well built app, and huge choice of UK and foreign shares.

We use Vanguard for our portfolio of funds within a SIPP. We love their low fees! They charge 0.15% (at time of writing) on the account balance (which is cheaper than their rivals), and they have very low fund management fees.

Concluding Points:

• Think about the account type that’s most suitable to your specific circumstances before jumping in and opening anything.
• Make sure your chosen Investment provider also meets your needs depending on how you will be investing and what you will be investing in.
• Vanguard charges a 0.15% service fee. If you are thinking about paying more than this then ask yourself what you are getting for the additional fee.