Paying tax may be something that we all have to do, and there might not be any way to get out of it, but there’s no reason to pay more than you absolutely have to. Take your savings account as an example: chances are that if you’re over 18 and not a student, you’ll be paying tax on the interest you earn on your savings. If you have investments, you’ll most likely have to pay tax on the dividends you earn, right?

However, there are also some interesting investments that you can make that help you to beat the tax man, perfectly legally. Probably the best known, and one of the most popular examples of this, is the stocks and shares ISA. Let’s find out more… 

ISA Investment – The Basics

Many people are already familiar with how a shares ISA works, but here’s a quick overview just in case. Essentially, ISAs offer you a tax-free form of savings. This means that you don’t have to pay tax on any interest or dividends you earn through your investment ISA. This means you maximise your investment and make sure your money is working is hard as it possibly can.

There are a couple of things to note when it comes to shares ISAs: there is an annual investment limit, which means you can only put a certain amount of money into your ISA in a single tax year. The current ISA allowance for 2011/2012 is £10680. You can choose to invest all of this in your shares ISA or split it and put half into a cash ISA instead – it’s up to you.

It’s also worth knowing that there are quite a few different shares ISAs around, from climate change ISAs (investing in companies that have lighter than average carbon footprints) to FTSE tracker ISAs, so it’s worth looking around to see which one would be best for you.

A good option, for many reasons…

But why should you consider investing in a shares ISA? There are lots of reasons you might want to invest your money, my friend Jason started an investment ISA after receiving some money from his family. His parents had downsized their property and, very kindly, passed some of the money they made on the sale down to their son with the aim of helping him get on the property ladder.

Of course, the property market being what it is, even his parents’ generous donation plus what he’d already saved couldn’t finance his mortgage deposit, so he decided to take the chance and go for an ISA with the aim of maximising his investment and eventually raising a deposit. In this case, he chose a FTSE all-share tracker ISA, which invests in all of the companies listed on that index.

Why that ISA? Essentially, he didn’t want to put all his eggs in one basket and was fairly new to investing so spreading the risk over a large number of companies seemed prudent. There were other options, but based on his situation and goals, he decided that one was best for him.

That’s not the only reason people consider investing in ISAs, though. You might come into money due to a competition win, a bonus from work, your own house sale or inheritance. You might be saving for a car, a holiday, your kids’ education, a rainy day… The important thing is making sure you choose the right ISA for your needs.

 Is the risk worth it?

As you probably know, there is a risk attached to shares ISAs. This is because they are investments and, like any investments, they aren’t guaranteed to grow. This means it’s a good idea to evaluate the risk before taking the plunge and do some research into different ISAs to make sure you get one with a good reputation. We can’t deny that some ISAs do underperform; however, the best stocks and shares ISAs are careful about where they invest and even though the economy has seen its ups and downs of late, there are still some very good ISA success stories around.

Also, if you invest wisely, it is possible to spread the risk and limit your chances of an unfortunate investment. For example, there are bonds and gilts ISAs available, which are still investments but are lower in risk than other ISAs attached to the stock market. You could alternatively split your money between a cash ISA and a share ISA, or put some into a regular savings account so you’re limiting how much is at stake.

Plus, there is a risk in not moving your money. It’s said that people are more likely to get divorced than they are to move their bank accounts, and millions of people end up leaving their money in savings accounts where the value is actually going down due to inflation and low interest rates. There might be a risk involved with shares ISAs, but there’s still a good chance your money will grow, unlike many current and saving accounts – and if you look at the performance of many ISAs over the past three years, it’s easy to see that even in challenging circumstances, it’s still possible for significant gains to be made.

Do you find that if, by the end of the month, you have some money left over, then you just can’t help but spend it? If your debts don’t require clearing immediately, then it can be difficult to put money to one side for when they do. If you have trouble doing this, then it can be a good idea to think about investing.

There are a number of different places in which you might choose to place your investments, although some may be more beneficial than other for those who are in debt. One of the most straightforward options, of course, if to simply place your money into a savings account. If you don’t mind placing your money within a bank or building society, but would rather it was somewhere that meant you were unable to spend it, then you may want to think about putting your money in an ISA, or other type of savings bond which does not allow instant access

If you want to earn more than basic interest rates on your investment, then you might want to think about putting your money in stocks, shares or commodities. However, for money of these options, it can be worth having some previous experience in investing, as well as the time to monitor any trading opportunities. Alternatively, investing in a commodity such as gold can be done online via sites like Bullion Vault, and is ideal for those who may not have and prior knowledge of the investment process. This is also a good option for those who may need to withdraw their investment at any point. Whilst funds cannot be access used a debit card, for example, they can be withdrawn at at time.

Lastly, you may also want to consider investing in property, or other such assets. For example, if you own your own business, then you may want to make investments which will somehow enhance the services which you offer. However, you will want to make sure that such investments do not also involve accruing further debts and expenses.

Earlier on this month I questioned whether to start saving for the sole purpose of buying a house, or going back to renting and continuing with the freedom to both save and invest, once I’ve paid off my debts.

At the time I didn’t have an answer, but I think I have made up my mind.

I will return to renting. Here’s why.

House prices remain inflated. Despite the credit crunch, house prices have not fallen very much at all compared to their explosive growth over the previous 9 years. While the term doesn’t fit precisely, the fact that property prices are reportedly on the increase again after “slumping” in my view is merely a dead cat bounce.

A mortgage is expensive. My generation has all but been priced out of house-buying, and the current bubble house prices remain in keep this so.  Even an interest only mortgage works out more expensive than the equivalent rental cost, and that’s even before taking into account the maintenance costs of buying rather than renting and other sundry ownership-related expenses.

I want to invest. Virtually all sources I have researched agree that financial freedom cannot be achieved by saving alone. If my desire to retire early is to become a reality, my money will need to work very hard for me and I cannot do this while tied to paying an expensive mortgage for an overpriced property. This therefore means that realistically any purchase of a house needs to be entirely made with cash once the market finally relents and corrects (or Gordon Brown stops shoring up the bubble, whichever happens first).

My inheritance may enable this. I hope not to have to cross this particular bridge for a while yet, but my grandmother left me a sum when she died. This was invested further in property by my parents and now (even post-crash) stands at around three times its original value in today’s money.

My father has a reasonable property portfolio that will one day hopefully pass to me, along with a unique liftetime accumulation of rare collectibles that may fetch anywhere from £5 to £1 million at auction depending on the day.

On my mother’s side I also have a share of their existing property.

If the figures I have are even remotely correct, then I have quite a tidy sum of future wealth to be realised at some stage, although the worth of that will vary greatly depending on when it becomes cashable, thanks to inflation. While I hope for the higher estimate, even the lower will enable the purchase of a nice property, with probably 50% still unused. The more left over the better as it’d be an excellent headstart on my compounding goals and investment plans.

All said however, I’m not in the habit of counting money I don’t have so while these figures are comforting, they may as well be written in monopoly money for the moment. The existance of possible inheritance a decade or more down the road does not change the fact I am still almost £5,000 in debt now and have no cash in savings that isn’t already earmarked for debt elimination.

My revised plan then is continue to work my way out of debt, finish my divorce, save hard for a further 12 months while resident with my parents – taking advantage of the minimal overheads that provides – and then look for a small rental property much closer to work. This will enable me to cut my diesel bill considerably as well as cut the time it takes me to get to work and back home.

Is this a sensible strategy? Would you do different?