Should you take a risk with your Isa?

You've decided to make the most of this year's Isa allowance before the tax year comes to an end, but that's just the first of a series of decisions you need to make. Next on the list are what to hold in your Isa wrapper - the main choice is between cash deposit accounts and stock market linked investments - and whether to go for a maxi or mini version.

A maxi Isa allows you to invest up to £7,000 in the equity market, or to combine cash and shares. Alternatively you could go for a set of mini Isas, with a combination of cash and shares investments. You can have both a cash mini Isa and a shares mini Isa in the same year, but you can't have both a maxi and a mini Isa. You can put up to £3,000 in your cash mini Isa and up to £4,000 into your stocks and shares mini Isa.

Although you can open a new Isa each tax year, you can't add money to your previous year's Isa, and once you have decided on a mini or a maxi Isa you can't change your mind.

Instant access
If you want instant access to your money a cash Isa will probably suit you better than the stocks and shares version. Almost all banks and building societies offer these and most operate like deposit accounts. However, be aware that some headline interest rates include a six-month bonus, so make sure you are comparing like with like.

Justin Modray, investment adviser with the IFA Bestinvest, says a cash Isa is the best option only if you will need your money within five years. "If you can tie up your money for five years or more, then shares are likely to offer better returns over the long-run," he says.

Rising share prices and a rash of company takeovers have given the UK stock market a welcome boost in recent months, and this has driven sales of stocks and shares Isas. According to figures from the Investment Management Association, net sales increased from £39m in January 2005 to £82m in January this year.

There could be more growth to come. Market specialists Fisher Investments has identified five positive factors which will drive share prices higher this year and may persuade more investors to choose a stocks and shares Isa. The company says:
·shares are still historically good value
·mergers and takeovers will stimulate activity in the market
·companies will continue to report good profits
·the global economy is healthy
·and inflation and interest rates should remain low.

Andrew Teufel, Fisher's director of research. "With the absence of any obvious catalysts for major trend changes in 2006, we expect last year's bullish themes to persist."

Go large
If you are interested in investing a greater proportion of your money in shares, then a maxi Isa is likely to be your best bet. Most investors who take these opt to invest in a fund where their money is pooled with that of other investors to spread the risk - these are known as collective funds and tend to be focused on a geographical area, for example the UK or US, or on a sector, for example technology or smaller companies.

You can buy an Isa and funds to hold in it through an IFA, a bank or direct from a fund management house. Alternatively you can choose your own individual shares and funds within a wrapper known as a self-select Isa. This allows you to trade shares or funds within your Isa as often as you like, but you will either pay an annual charge or a proportion of the value of your holding as a fee.

Initial charges on funds can be as high as 5%, but you can avoid them by buying your Isa through a discount broker like Bestinvest or Chelsea Financial Services or a fund supermarket, like Fidelity Fundsnetwork, who will refund a chunk of the initial commission.

Spreading the risk
The more time you have and the more you can afford to lose, the greater the risk you can take with your money and the greater your potential returns. However, Justin Modray says people often find it difficult to quantify their attitude to risk. "A good rule of thumb is to decide how much of your money you could bear to lose in a year - from nothing to 30%. If you can't afford to lose any money then you are better off in cash." Those with a slightly less cautious approach could choose a combination of cash and shares mini Isas to spread their risk.

Ben Willis, investment manager at IFA Chartwell, says that investing regular amounts of money into shares via a maxi Isa means that you can ride out the highs and lows of the market, a practice known as "pound cost averaging". "This takes away any attempt to second-guess the market," he says.

You may have left it too late to set up a regular payment this year but some companies like Cofunds and Fidelity Fundsnetwork allow you to invest the full £7,000 of your maxi Isa now in cash and then drip-feed it into the market over the next six months.

Jason Hollands, head of communications for fund management company Foreign &Colonial, says if you are investing in funds it makes sense to take advantage of your Isa allowance each year, as you will pay no capital gains tax on your profits.

"If you are going to invest in funds then it almost certainly makes sense to invest your first £7,000 each year via an Isa - even if you are not currently a tax payer, since in most cases there will be no extra cost for the wrapper," he says. "By building up a pot of Isas, it keeps your money tucked away from the chancellor in future years when your tax status may have changed."