Stock picks for ISA selection

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Although placing shares in an ISA is not technically tax-free, if you like to actively buy and sell stocks rather than funds (or maybe there's room for both in your portfolio), it makes sense to wrap them up in the most tax-efficient way.

By buying shares in an ISA, you save paying capital gains and income tax, but there is a 10% dividend tax credit that can't be reclaimed.

As with cash ISAs, with other investments you can put in a stocks and shares ISA, the benefits really stack up for higher-rate taxpayers.

For more help and expert advice on what to do with your allowance this year, visit our 2011 ISA guide.

So if you think your gains will exceed the £10,100 annual capital gains tax allowance, sheltering the shares in an ISA will save you 18% if you're a basic-rate taxpayer and 28% for higher-rate taxpayers. Furthermore, higher-rate taxpayers usually pay 32.5% tax on dividend income, but this is capped at 10% in an ISA.

There are a few small restrictions with shares you can place in an ISA. Lee Smythe, managing director of financial planners Smythe & Walter, explains: "You can generally invest in any shares listed on a recognised stock exchange.

"Shares in unlisted companies and those listed on an unrecognised exchange, such as AIM, are not allowable in an ISA unless they happen to have a listing on a recognised exchange as well, but this is quite rare."

David Jeal, head of product management at Selftrade, points out that there are a few investment trusts that aren't allowed in an ISA either. Shares in certain exchange traded funds might also not be permitted.

Some ETFs cannot be held in an ISA because of where they are listed or what they are invested in. However, the ETF issuer and ISA provider make that decision, so in practice you should not be sold an ETF that isn't eligible for your ISA.

It's not just tax perks that investors should consider when deciding if investing in shares through an ISA is right for them.

Anna Sofat, managing director at Addidi Wealth Management, says investors need at least £500,000 to build a truly diversified ISA full of shares. However, she adds that investors with smaller pots could hold individual shares in which they have high conviction or where they are prepared to take a speculative view.

"With high conviction shares, you would look to buy and hold for the long term so regular reviews might not be that necessary, but with the speculative shares, you would want to keep an eye on the markets and share price. There are a number of websites where you can set price or market alerts which can be used to monitor the movement in share price," she says.

So what's the outlook for the UK stockmarket this year? Smythe thinks 2011 could be promising for UK equities, and he anticipates energy stocks will perform well on the back of higher oil prices, but retailers may feel the pinch from higher taxes and less consumer spending.

Sofat says a 10% increase this year "would not be unreasonable", although it is unlikely to be a nice steady rise.

"There is still a risk of sharper falls and this could happen if the bond market does unravel following the inability of the politicians to handle sovereign debt issues correctly," she says. "I favour big health and utilities companies; these did less well last year than the cyclical shares. I also like small caps, in the technology sector in particular."

In the table are some tips on which companies might perform well this year: 10 options for aggressive investors who want good returns and don't mind risk, and 10 for more cautious investors.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

This article was taken from the March 2011 issue of Money Observer.