What is a stocks and shares ISA and how does it work?

If cash savings aren’t delivering the returns you want, it can be worth considering a stocks and shares ISA.

Similarly, if you’d like to start investing in the stock market, this kind of ISA is a good first step.

This guide shows you how they work and gives an overview of some of the options, from index tracker ISAs to riskier exchange-traded funds (ETFs) focusing on emerging markets.

Learn more: ETFs vs index funds: what's the difference?

Whether you're a beginner or a more experienced investor, here’s what you need to know about stocks and shares ISAs to get started.

What is a stocks and shares ISA?

An individual savings account (ISA) is a tax-efficient savings product. Interest or growth from an ISA isn’t subject to tax in the way that ordinary savings or investments would be.

ISAs may, therefore, deliver more reliable long-term growth than many of the alternatives.

You can save up to £20,000 per year into ISAs, which is known as your ISA allowance.

A stocks and shares ISA holds investments instead of cash. Despite the name, it can hold a wider range of investments than just stocks and shares, and may include bonds, investment funds and investment trusts too.

Typically, you will choose an ISA provider, who then offers you a range of products, which may be ready-made or bespoke.

How do stocks and shares ISAs work?

When setting up your stocks and shares ISA, you can choose what investments to place inside it.

This is a critical step that determines both the risk level and potential growth of the ISA, so it’s worth taking financial advice at this point.

You should carefully read the documents from your ISA provider, to ensure you understand the various funds and assets in which your money will be invested.

When you invest in a fund via your ISA, you will purchase units (essentially your share of the fund), which will go up and down in price depending on the price of the underlying assets each day.

So if a fund unit costs £1, you could purchase a thousand units for £1,000. If the price of a unit rises to £1.20 a few months later, your investment will now be worth £1,200.

If it drops to 80p per unit, then you’ll have £800, and so on.

Shares held in a stocks and shares ISA can also benefit from dividends if the company chooses to pay them. This can further boost the tax-free growth of an ISA.

What are the benefits of a stocks and shares ISA?

The obvious benefit of a stocks and shares ISA is that it allows you to invest in a range of investments without paying capital gains tax (CGT) on the growth, which you might otherwise have to do if you exceed your CGT allowance.

This can be particularly useful if you’ve made other capital gains elsewhere in that year, such as by selling a second property.

Selling a large asset like this can wipe out your CGT allowance, so holding other investments in an ISA can protect that growth from tax.

A stocks and shares ISA is also a great introduction to investing in general.

Remember, your ISA is simply a vehicle for investment, rather than a type of investment, so you’ll have plenty of choice regarding your assets.

You can get a feel for how different types of investments behave over time, and how to judge the right level of risk for you.

This can be very useful if you plan to expand your investments beyond ISAs in the future – but even if you do, you should always use up your ISA allowance first, for the valuable tax benefits.

Another clear benefit of a stocks and shares ISA over a cash ISA is that the potential for growth is higher.

A cash ISA is limited by the interest rate offered, and if the Bank of England base rate is low (as it was years ago), your account may pay little interest.

In this case, your interest rate may not beat inflation, so the real value of your savings may actually diminish over time.

Furthermore, the personal savings allowance means that the first £1,000 of interest on cash savings is tax-free.

However, as interest rates have risen alongside the base rate, more people have been worried about paying tax on their interest.

By contrast, a stocks and shares ISA offers the potential for actively growing your money over time to beat inflation while saving you tax at the same time. Of course, this comes with an increased level of risk, which we’ll cover next.

What are the disadvantages of a stocks and shares ISA?

Stocks and shares are considered high-risk or ‘volatile’ assets. Volatile means they are prone to sudden changes in value, either rising or falling.

This means that any investment in the stock market can go down and up, and a market crash can result in heavy losses.

For this reason, equities are not recommended as a short-term investment except for very experienced investors who know how to ‘time the market,’ and even these experts may frequently get it wrong.

This volatility means it may not always be practical to access your money when you need it.

While you can usually withdraw from a stocks and shares ISA within a few days (you have to wait for the investments to be sold and converted into cash first), it may not be a good time to sell.

For example, if you have spent five years watching your investment grow, only for a market crash to wipe out much of that growth, you will not want to sell at this point and waste five years of investing. It will be sensible to wait for your investment to recover or even grow in value.

This may place your ISA temporarily ‘off limits’ for you, except in a real emergency.

Ideally, you will want to plan any withdrawals carefully so that you sell at a time when your investments are doing well. This can be hard to predict, so it’s best to err on the side of caution.

As for other disadvantages, the ISA limit of £20,000 per year restricts the amount you can put away.

If you have a lot of money to invest, you’ll have to look at less tax-efficient alternatives in the short term and drip-feed your money into ISAs.

However, you may decide to use all your ISA allowance for stocks and shares and put your cash into regular savings accounts instead.

Should I invest in a stocks and shares ISA?

A stocks and shares ISA can be a great vehicle for saving for mid-term or longer-term goals.

If you have money that you feel able to put away for several years without touching it, then a stocks and shares ISA will, in most cases, deliver better value than cash savings.

Stocks and shares ISAs are particularly popular for junior ISAs, where saving can begin when the child is a baby and continue until they reach 18.

18 years is a very good length of time for stock market investment, and historical growth over similar periods period has almost invariably beaten inflation and cash savings.

Though still vulnerable to stock market crashes, a Junior ISA containing stocks and shares is generally a better choice than a cash one.

Stocks and shares ISAs can also be good for saving up for long-term goals, such as buying a home or retiring.

Both of these goals can be achieved via a lifetime ISA (which may be either cash or stocks and shares), but these come with certain restrictions, so some savers may prefer a standard stocks and shares ISA.

Learn more: What is a lifetime ISA and how does it work?

It is worth bearing in mind that a cash ISA is not risk-free. With cash, you risk missing out on growth, or your money losing value due to inflation.

This is something to consider when weighing up the risks and rewards of the different types of ISA.

How to buy a stocks and shares ISA 

To open a stocks and shares ISA, you’ll need to decide how much you want to invest.

Remember that you can invest up to £20,000 of tax-free money into an ISA, so decide what proportion of that amount you’d be happy investing (or can invest).  

You then need to select a platform or provider to open your ISA.

You can choose what stocks and shares you want to invest in, use an expert to take care of this, or potentially pick from a pre-set ISA with a set number of investments. 

If you choose to pick your investments, you should pay close attention to additional fees that you will need to pay when carrying out your investments.

Platforms and providers will charge fees, meaning you could end up with less than you had originally calculated.  

Robo stocks and shares ISAs

Some ISAs may not even need any manual interference at all. So-called ‘robo-ISAs’ rely on complex algorithms and artificial intelligence to make investment decisions for you.

Robo-ISAs are not cheap, but based on your criteria and risk profile, they will generally include predictable investment strategies, meaning you only need to pay attention to your returns.

Who provides stocks and shares ISAs?

Many well-known banks and large investment companies offer stocks and shares ISAs. If you want to keep the fees low, a cost-efficient option could be to use an online platform.

If you’re a confident investor, you can opt for a DIY trading platform, which will offer you little to no direction or guidance and usually have lower fees.

Popular options include Moneyfarm and interactive investor.

There are also platforms that can offer more advice, and fully-managed investment options that decide where to invest on your behalf.

However, you will generally have to pay higher fund manager charges if you go for a fully managed option, which can reduce your returns.

Wealthify and Hargreaves Lansdown are some of popular options.

How to pick the best stocks and shares ISA provider

You’ll need to do your own research before choosing a provider, as each option has different pros and cons.

The cheapest option won’t always be the right one for you.

Make sure you’re considering factors such as:

• Which funds you can access
• The number of funds
• The annual platform charge
• Transfer out fees
• Account closure fee
• Fund dealing charge

It’s also sensible to consider how easy your chosen platform is to use.

If you’re going to be regularly trading, an easily accessible app will make it simpler for you to do so, while platforms that automatically reinvest dividends will suit passive investors looking for good returns.

A comparison website will make it easy to compare options if you know what you’re looking for.

There’s no one-size-fits-all stocks and shares ISA, so getting impartial advice from a financial adviser can make it much easier to find the right option for you.

They can help you pick the right investments for your circumstances and manage your portfolio on your behalf. 

What should I invest in with my stocks and shares ISA?

You can invest in whatever you like, but the first thing you should consider is what you’d like to achieve through investing.

Is stability a priority, or are you happy to risk losses in exchange for the chance of higher returns? Are you investing for a specific purpose (such as retirement or to build a nest egg for your children) or are you trying to make your money work harder than a savings account?

Next, think about the impact you want your investments to have. Are you driven by ethics and wish to support other companies/causes that share your ethos, or are other factors more important to you?

You’ll also need to consider how much work you’re willing to put into managing your funds and how long you’re happy to tie them up for.

Again, if you’re not sure, it’s best to get advice before investing – making ill-informed investments could be a costly decision.

What are the best performing stocks and shares ISA funds in 2024?

Here’s a quick snapshot of 10 of the most popular ETFs as of June 2024, which could be invested in via a stocks and shares ISA.

However, and this is important to remember, you should not take past performance as an indicator of how an investment will perform in the future.

The best ISA funds to invest in will change regularly, particularly in unpredictable economic conditions, so you’ll need to do your own research before investing in anything.

Again, a financial adviser can help you with this decision, as they will have seen different funds perform over a full market cycle.

Also the meaning of ‘the best performing ISA’ will change depending on your goals.

An investor looking to make lots of money relatively quickly and an investor seeking steady growth over a longer period will not be drawn to the same products.

Stocks & shares ISA FAQS

How do I withdraw money from a stocks and shares ISA?

You’ll be able to withdraw money via your chosen platform.

If you don’t have any available funds, such as dividend payments, in your ISA, you’ll need to sell some or all of your investments to access the money.

How many stocks and shares ISAs can I have?

You can open and pay into more than one stocks and shares ISA each tax year.

If you see a better deal you can open a new stocks and shares ISA.

Can I invest for my children?

Yes. Parents or legal guardians can open a junior stocks and shares ISA on their children’s behalf. They work in the same way as adult stocks and shares ISAs.

The tax-free allowance for Junior ISAs is £9,000 for the 2024/25 tax year.

Can I invest in foreign companies?

You can invest in foreign assets, but you can’t hold foreign currency in your ISA.

This means purchasing international shares via an ISA can be an expensive option, as you’ll have to pay for costs for it to be hedged back to sterling.

You’ll get more from your money if you invest in foreign shares outside of your ISA. 

What if I want to invest in only ethical companies?

Many platforms allow investors to choose ethical investments.

For example, Nutmeg has a ‘socially responsible option’ that helps you invest in companies that score highly for environmental, social and corporate governance (ESG) factors.

You can also choose ETFs that focus on themes such as sustainable energy or climate change-focused enterprises.

Can I transfer my cash ISA into a stocks and shares ISA?

You can transfer into a stocks and shares ISA, and choose how much you want to transfer.

What happens with dividends that I receive from a stocks and shares ISA?

Any dividends that are paid to you from shares in your ISA will be tax-free.

You can withdraw your dividends or reinvest them, provided you’re below the ISA allowance.

Can you lose all your money in a stocks and shares ISA?

As with most higher-risk investments, there is a chance that you can lose everything when you invest in stocks and shares.

However, numerous investment funds exist where the risk is spread across a range of different assets, such that only an unexpected event could result in a total loss (for reference, the COVID-19 pandemic wiped about 35% off the FTSE All Share index).

Your level of risk will depend largely on the type and range of assets you hold in your ISA. Generally speaking, you should not invest more than you can afford to lose.

What are the alternatives to a stocks and shares ISA?

The two main alternatives to a stocks and shares ISA are a cash ISA and an innovative finance ISA. The pros and cons of a cash ISA are covered above.

An innovative finance ISA is similar to a stocks and shares ISA in terms of risk, but it invests instead in peer-to-peer (P2P) loans.

The other alternative is to invest in assets outside of the ISA wrapper. You can do this, but your gains will be subject to CGT above your allowance.

You will also need to pay dividend income tax on any dividends you receive.

If you found this article helpful, you might also find our articles about stamp duty on shares and how many ISAs you're allowed informative.