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An innovative finance ISA (or IFISA) is the third type of ISA available to UK investors, after cash and stocks & shares ISAs. It is specifically intended for investors to use their tax-free ISA allowance to invest in peer to peer lending.

Peer to peer lending is where your investment is lent to borrowers and businesses, who then pay back the amount with interest based on the length of your investment.

You can only pay into one IFISA in each tax year. However, you can pay into a cash, stocks and shares and innovative finance ISA in the same tax year as long as you do not exceed your total yearly ISA allowance (currently £20,000). This allows investors to invest across several savings options.

IFISAs explained

Implemented in 2016, IFISAs are designed to give investors a range of different investment opportunities to consider outside of the traditional stocks and shares format. From litigation funding through companies like Just ISA to property investment and business loans, there are IFISA opportunities available across a wide range of markets and sectors.

With higher interest rates on offer when compared with cash ISAs, a comparatively low minimum investment level, and investment period usually starting from 3 years, these IFISA opportunities can be seen as (and are often marketed as) promising starter investments for those looking for longer-term savings.

The huge range of markets available to IFISA providers gives potential investors many options for where to put their money.

However, as a comparatively recent addition to the finance market, IFISAs can be much more complex for potential investors than other traditional ISA options. There are a number of IFISA comparison websites already set up to give potential investors an overview of their options.

IFISAs commonly differ from normal ISA offerings by increasing the options for investors to consider. Whilst a cash ISA is commonly held with a bank or building society and offers low interest and low risk, the wide range of investment areas on offer with IFISAs often leads to increased interest rates at the expense of increased risk.

Many current IFISAs are more dependent on the success of the projects they are set up to fund than traditional investment options would be. Litigation-based IFISAs, for example, use your investment to finance legal cases brought by third parties. Return on investment is then dependent on the success of the cases being funded. In the case of property IFISAs, return is dependent on the successful completion and then sale of the property in question.

As IFISAs function as peer to peer lending, some companies also use IFISAs as a means of gaining direct investment (often through bonds) into their own projects or partnerships. In this scenario, the company acts directly as the borrower, which can introduce further issues such as a lack of diversification of funds.

What are the risks associated with IFISAs?

Whilst there are a range of risks associated with any investment, there are always several things that investors should be aware of (and are often caught out by). Every company offering IFISAs should have a complete and comprehensive breakdown of the risks associated with their sector.

Risks to IFISA investments can include:

  • the borrower defaulting on the loan created by your investment, or
  • failure to raise enough capital to properly explore the chosen market.

IFISA investment opportunities often carry a series of fees payable by the investor to the management company – which will have some impact on the net return of the investment. These fees are usually set out in the terms and conditions of the investment. Those considering investing smaller amounts should be especially careful of the impact that fees could have on their eventual return.

Whilst some IFISA opportunities are more sheltered from external financial events, especially if you avoid investment in areas with volatile markets, the companies offering investment into the IFISAs are not. The trading and assets of funders could be affected by unforeseen events, including economic, social and political events or trends.

Whilst these events are unlikely, it is always worth taking the current financial and political climate into consideration when deciding on the best method for investing your funds and planning accordingly.

Investment in IFISAs can also mean a lack of diversification in an investment portfolio. Diversification – spreading your investments over a number of areas and markets – is a common means of reducing overall risk. When you invest in IFISAs focused on specific financial sectors, like precious metals, you should be aware that all monies invested will be in the same sector and through the same asset class.

IFISAs are a comparatively new area of investment, although the number and range of opportunities to investors are growing rapidly. Whilst there are increased risks, this is usually counter-balanced by increased rewards. With proper consideration, preparation and advice, IFISAs can be a good long-term investment for investors of all levels.

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