The most common ISA mistakes and how to avoid them

Even in strong markets, investors can make costly mistakes — often without realising it. From relying too much on cash to missing out on dividends, small missteps can compound over time. Here’s a closer look at the wealth-denting factors to avoid, helping you make the most of your ISA allowance.

Please remember that the value of investments will fluctuate and returns may be less than the amount originally invested. Tax treatment depends on your individual circumstances and the ISA and tax rules can change. Chelsea does not offer advice and so you must manage your ISA yourself.

Neglecting income

Stock markets have had a very good couple of years. The MSCI World index was up 24% in 2023, and 19% in 2024*. It is possible that it may see the same magnitude of growth in 2025, but it would be unusual. This is likely to mean that dividends will become a greater share of your overall return.

This is much more the norm in history. Stuart Rhodes, manager of the M&G Global Dividend fund, points out that dividends have accounted for the majority of total equity returns over the past three decades. Compounded over time, dividends can be a potent source of returns for investors.

Dividends also tend to be a more predictable source of return. There have been periods – such as during the pandemic – when aggregate dividends have fallen, but they have generally bounced back quickly. Also, dividend payouts from companies usually increase in line with inflation. The M&G Global Dividend fund has a specific target of increasing its dividend stream year on year.

Being too cautious

Investors subscribed to around 12.4 million adult ISA accounts in the tax year 2022/23**. This suggests the UK has some healthy savings habits. However, around two-thirds of those ISAs were in cash and this continues to grow, in spite of the strong performance of stock markets. In the same year, the number of people subscribing to stocks and shares ISAs decreased by around 126,000**.

There is nothing wrong with cash. Holding a proportion of your wealth in cash as a cushion against tougher times is a sensible strategy. However, advisers tend to recommend that this is 3-6 months’ worth of expenses and certainly not the entirety of your savings. The danger in being too cautious is that the purchasing power of your savings doesn’t keep pace with inflation. If you have 3-5 years to invest, a stock market investment is likely to be more profitable.

If you’re nervous about volatility, there are plenty of low volatility fund options that don’t bear the full weight of stock market ups and downs: for example, the VT Chelsea Managed Cautious Growth fund. The most cautious in our range, we aim to produce growth over the long term, but with lower volatility than equity markets. While returns may not be as high as you could potentially get in the Aggressive fund, you'll also be taking much less risk.

Not being diversified

This is a particularly important consideration for this year. Investors have gravitated towards a handful of technology stocks and global stock markets now look highly concentrated. This hasn’t been a problem while they have been performing well, but the recent wobble for Nvidia should remind investors that there is risk involved.

Be careful how much you have in the technology giants and make sure you are diversified elsewhere. Recently, we looked at five alternatives to technology. They may continue to go from strength to strength, but you don’t want to leave yourself vulnerable if they don’t.

Additionally, we see growing concerns over a US-centric approach. With an unpredictable US administration, and some of the US’s largest companies may potentially be in the cross-hairs of the tariff regime, it might be time to consider European and UK markets over the US.
So far, Europe appears to have been the main beneficiary in spite of the region’s relative lacklustre economic performance. We’d suggest CT European Select, or Liontrust European Dynamic.

Leaving it to the last minute

The temptation with ISAs is to ignore them for most of the year and then frantically cram in as much as possible at the end of the tax year to make sure you use your allowance. This is not the best approach. Studies suggest that those who invest early in the tax year are better off than those who leave it to the last minute.

This is logical. Stock markets don’t always go up, but they have gone up in 10 out of the previous 14 years*, so by investing early, you’re more likely to benefit from stock market growth. Equally, if companies pay dividends, you’ll get more of them. Overall, investing early in the tax year means that you get the benefit of tax-free compound growth for longer. As the old saying goes, “it is time in the market, not timing”.

*Source: index factsheet, 31 January 2025
**Source: HM Revenue & Customs, commentary for annual savings statistics, September 2024

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.