Planning where to allocate your ISA allowance is key to developing your wider portfolio, and many experienced investors will already have an understanding of where to invest their 20/21 ISA allowance.
And given the growth of Innovative Finance ISAs (IFISAs) and that of the wider alternative finance market which they were introduced to support, it wouldn’t be unsurprising to hear many experienced investors are considering an investment into this ISA product.
Their ISA tax wrapper - which means investors have no tax to pay on interest or capital gains - and generous target returns often between 4% and 10% make IFISAs an attractive investment opportunity.
But unlike Cash ISAs where returns are guaranteed, IFISAs are an investment and so capital is at risk, meaning you must be fully confident they are the right product for you - and there are a number of questions to ask yourself before investing, with these five of the most notable.
1. Is the IFISA the right product for my investor status?
Broadly speaking, IFISAs are targeted at the more experienced investors; investors who can classify themselves as being a sophisticated investor, a professional investor or a high net worth individual.
As an investment product, there can be a lot to account for to ensure the risks and returns are fully understood. Experienced investors will generally be much more aware of such information and will be able to make more informed decisions on investing.
Whilst everyday investors (also known as ‘retail’ or ‘restricted’ investors) aren’t excluded from investing into an IFISA, they do face more limitations (particularly when looking at the Debt-Based Securities (DBS) options).
Investments into DBS via an IFISA are possible for retail investors, but they should only happen on the basis of independent financial advice, and to a value of no more than 10% of their investable assets.
2. How much can I invest in this IFISA?
Looking at how much you can invest into an IFISA produces a number of related questions, but there are two that should drive your decision primarily.
The first is how much of your total ISA allowance can you invest. If 6th April came around and you placed some money into a Cash ISA, this would reduce the amount of money you could invest into a new IFISA. A £1,000 investment would mean (as of 2019/20), the maximum you could invest into an IFISA is £19,000.
With that said, this only relates to new money; new funds you’re placing into your ISA products that aren’t coming from another ISA product. Most ISA products provide the option for investors to transfer money from another ISA product without impacting on their annual ISA allowance - so a £20,000 transfer from a Cash ISA to an IFISA would still afford you the ability to invest another £20,000 in new funds.
The second is how much you can invest when looking at the level of risk you want to be exposed to, be that in terms of your ISA investments or your entire portfolio.
For instance, if you invest £20,000 every year into an ISA, but only ever in a Cash ISA, switching to put the entire allowance into an IFISA may introduce a high risk level for your general preferences. However, splitting your allowance 50/50 may provide the balance you want between the security of a Cash ISA and the higher risk - but the higher return potential - of an IFISA.
3. What will I be investing into via the IFISA?
The IFISA was introduced to support the growing alternative finance market, and there are two high level options:
Peer to Peer (P2P) loans - these are loans to individuals or companies made by an investor (or group of investors) and are facilitated by online platforms.
Debt-Based Securities (DBS) - asset-backed investment opportunities, often in the form of mini-bonds, investors can invest into projects such as property and green energy.
Within these two options, you then have four options (consumer loans, business loans, property bonds and green energy bonds) and then an almost innumerable amount of options once again, depending on a variety of factors, such as your preferred level of risk to how long you wish to invest your money for.
A particularly appealing part of the IFISA product for many investors is the variety of options available, allowing for the IFISA to essentially be tailored to each individual investor’s portfolio requirements.
However, it does mean that an investment into an IFISA is very different to its sibling ISA products, most notably the Cash ISA, where there are no options for investors once your money is invested - it’s very much a ‘hands off’ approach.
With an IFISA, you need to fully understand where your money is being invested - and all of the related components, such as target returns and return period - to ensure it’s the right IFISA product for your portfolio needs.
4. Am I happy with this IFISA’s risk and return profile?
The relationship between risk and return is an undoubtedly important consideration, and investors need to have a full understanding of the risks of an IFISA before committing to it.
The IFISA is an investment product. It is not a savings product (even though others within the ISA wrapper are). Therefore, whilst it can offer high returns, these returns are not strictly guaranteed and your capital is at risk.
However, many experienced investors consider an IFISA because its risk and return profile arguably position it between a Cash ISA and a Stocks and Shares ISA.
Cash ISAs are relatively safe, with Financial Services Compensation Scheme (FSCS) protection of up to £85,000 if the ISA provider was to fail, but they offer staggeringly low interest rates - with the highest on the market right now sitting at 1.31%.
On the other hand, a Stocks and Shares ISA can offer high, inflation-beating returns, but as these returns are at the mercy of the daily fluctuations of the stock market, they’re extremely volatile. Stocks and Shares ISAs are covered by the FSCS for up to £50,000, but this only protects you if your Stocks and Shares ISA provider fails, and not in the event of your investments performing poorly.
Switching focus to the IFISA and investors can target better rates of return than those of a Cash ISA, with more assurances in terms of security and less volatility than is generally found with a Stocks and Shares ISA.
Read more: IFISA: understanding the risks vs the returns
Importantly, IFISAs are not protected by the FSCS, but reputable IFISA providers should have systems in place to help mitigate risk, and be open and transparent as to what they are.
Similarly, as many IFISAs are asset-backed, this means any investment you make is secured against an asset (such as a property) and in the event of default, you have a legal right to sell the asset to get your money back.
But with this said, while investing into an asset-backed IFISA can add a layer of protection, it doesn’t make your investment completely risk-free and investors have to be confident they’re happy with the level of risk involved in the investment.
5. Am I comfortable with locking away my money for a fixed term?
Though some IFISAs are flexible - meaning you can withdraw and replace money throughout the tax year without it affecting your annual ISA allowance - most require your funds to be invested for a fixed term, usually between two and five years.
This means that before investing into an IFISA, you must be certain that you won’t need access to your money before the end of the agreed term.
It’s for this reason why IFISAs should be considered a medium term investment option. Unlike Cash or Stocks and Shares ISAs where money can be readily accessible, the potential of greater returns with IFISAs does require a certain level of commitment.
However, it is advisable to check with your preferred IFISA provider what their rules are regarding early access to funds, as although it shouldn’t be considered possible by default, many providers do allow it in exchange for a specified fee.
Investing in an IFISA
Innovative Finance ISAs (IFISAs) have grown hugely in popularity since they were introduced in April 2016. Surpassing the £1 billion investment mark in 2019, they are proving to be an extremely popular option for experienced investors.
Providing the ability to target high rates of return, whilst also offering the opportunity to diversify and incorporate a variety of risk levels into your portfolio, it’s little surprise that investing into an IFISA has gained such popularity in just a few short years.
And with such an array of options now available to investors when it comes to IFISA choice, it’s vital you understand the questions to ask to ensure you chose the most suitable product for your specific portfolio needs.
The CARLTON Bonds product is available exclusively to experienced investors who are classified as either sophisticated investors, high-net-worth individuals or professional investors and have the knowledge and experience to make their own investment decisions. Investments are high risk and illiquid, your capital is at risk and returns are not guaranteed. Bonds are not protected by the Financial Services Compensation Scheme (FSCS).