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How to make the most of your Isa

AS April and the end of the current tax year comes into view, investors' attentions are once more being turned to the Isa (individual savings account) season.

Judging by the mood among investment managers, it would seem there will be little encouragement for investors to plump for the cash version of the tax efficient savings platform in the next financial year.

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With the Bank of England continuing to keep interest rates in check - they have remained locked at 0.5% since August 2009, with the Bank's policy now being guided by factors such as wage growth and levels of part-time voluntary work as well as unemployment - investors are being urged to eschew cash Isas in favour of the stocks and shares equivalent.

The new Isa allowances, announced by the Chancellor in December's autumn statement, entitle savers to invest a maximum £11,880 free of tax in the year ending April 5, 2015. They can invest the full amount in a stocks and shares Isa, or split the investment by putting £5490 into a cash Isa and the same into an equities product.

Nutmeg, the online investment manager, said it is hard to argue a case for cash Isa. Taking average interest rates and inflation into account, it claims cash Isas opened in each of the last 13 years have fallen in value in real terms.

"If you'd invested the maximum in a cash Isa every year since they began, you would have put away a total of £56,040 by now," said Shaun Port, chief investment office at Nutmeg. "With interest, that could have grown by nearly 20%.

"However, factor in inflation and your total savings would have actually gone down in value. "Compare that with putting the same amounts into a medium-risk portfolio of stocks and shares each year since 1999. Your money would have gained value in every year but one, and would have done better than the cash Isa for each of the last 15 years.

"Again that's in today's money after accounting for inflation."

Nutmeg said poor returns offered by cash Isas have led to speculation that savers could desert them.

This chimes with research from uSwitch, which suggests the number saving into a cash Isa will fall by 9% this year.

More than four in 10 said they use their current account as their main way to save, with around one in 10 (11%) citing low interest rates as the reason they are not saving in Isas.

By contrast, investment managers are highlighting the prospect of better returns for savers from stocks and shares Isas.

Wealth manager Brewin Dolphin suggests that investing your Isa in equities can even make you a millionaire within three decades, provided certain conditions are met - a claim also made by Fidelity Worldwide Investment.

Brewin Dolphin revealed it has 15 clients whose Isa pots have broken the million-pound barrier, while a further 40 have assets held in Isa wrappers worth more than £750,000.

Based on what it says are conservative assumptions on growth and income (5% combined) and inflation at 2.5%, a fund of £1,030,953 could be amassed by a saver using their full Isa allowance by 2042. This represents a gain of £522,180 on a total investment of £508,773. "Saving in a tax-efficient wrapper remains one of the most compelling ways of realising your long-term financial ambitions," says Guy Foster, head of portfolio strategy at Brewin Dolphin."During its life, the WMA Balanced Total Return index has returned compound annual growth of 8.5% - despite the so-called lost decade for equities after 2000.

"Even now, with the FTSE paying seven times as much income as bank deposits, we have assumed a more conservative 5% return and still an investor using their full Isa allowance each year could be a millionaire in 27 years with no tax to pay on their gains."

Investors opting to place their Isas in equities have important calls to make, meanwhile.

Jason Hollands at Bestinvest said picking funds this year is tricky, noting that value is harder to find after the exceptional returns provided by many developed markets in 2013. He also highlighted the risks spinning out from the winding down of measures aimed at stimulating the US economy, which he said was leading to volatility in emerging markets, as well as fixed income and Japanese equities.

Against this backdrop, it has highlighted "six of the best" that may appeal to different investors.

These range from cautious options such as the Jupiter Absolute Return (targeting a 6% per annum return after fees) to the medium-risk Cazenove UK Equity Income (adapted to suit each stage of the business cycle, positioned towards recovery plays) and the AXA Framlington UK Mid Cap, which Bestinvest contends is "better positioned to benefit from the UK domestic recovery than most".

Bestinvest also flags the Aberdeen Global Asian Smaller Companies fund "for the long-term thrill seeker". Hollands noted that, while this fund's holdings are "higher risk companies in volatile markets, the approach is a conservative one, with a strong emphasis on buying companies that are at reasonable to cheap valuations".

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