Earn A Tax-Free Return Of 543%

Invest in the right stocks and shares ISA fund and you could earn an excellent return on your money.

There's an awful lot of money held in stocks and shares ISAs. In fact, at the end of last year they were collectively worth a whopping £54 billion*. So, if you want to earn some tax-free cash before the next ISA deadline on 5^th April, where should you invest your money?

If you don't dare go near shares but you still want a tax-free return, have a look at my recent article, Bag A Top Cash ISA Today, for some great cash ISAs. Those of you who are prepared to brave the thrills and spills of the stock market, read on!

The trouble with stocks and shares ISA funds is there's hundreds of them so choosing the right one can be tricky. Should you invest in far flung places or stick closer to home? Should you invest in large, well-established companies or fledgling start ups? It can be a pretty daunting decision, especially if you have never invested in shares before.

But the beauty of ISA funds is you don't actually need to select the individual shares yourself. Phew! This is the job of an 'expert' fund manager. But you'll need to put your thinking cap on when it comes to deciding between the fund managers themselves. Some are a lot better at selecting stocks than others, so be very careful when deciding who you should entrust your money to.

And you'll have to make all these decisions quickly because there's less than six weeks left to the deadline for using this tax year's £7,000 ISA allowance.

Popular Sectors

So, first of all, let's take a look at what other investors have been doing.  ISA funds are divided into sectors which usually denote the types of assets held, where in the world the fund invests and sometimes the management style of the fund.

For example, the lion's share of ISA money is invested in our home market in funds included in the UK All Companies sector. At the end of 2007 around £12.5 billion* was held in funds like these which invest primarily in the shares of UK companies.  

Although UK All Companies is the most popular sector overall, the Cautious Managed sector is currently enjoying the most support from ISA investors in terms of recent sales*. ISA funds in the Cautious Managed sector hold no more than 60% in shares which tend to appeal to more risk-averse investors, particularly when stock markets are volatile.

If In Doubt, Go For A Tracker

If you don't know what type of fund you want but you like the idea of stock market exposure, I suggest you consider a decent index tracker fund. As I explained in An Easy Way To Invest In Shares, index tracking ISAs are a great way of earning a competitive return at a low cost. I like Legal & General's UK Index Tracking Trust which is pretty cheap and has a good track record.

An index-tracker fund has a simple investment strategy which is designed to follow or 'track' a particular share index, such as the FTSE 100, with the aim of replicating its performance as closely as possible.

Trackers are often referred to as `passively' managed because they don't need an active fund manager to pick stocks. This is why they tend to be cheaper than actively managed funds. What's more, they tend to perform better over the long-term too.

But if you fancy something a bit more adventurous, a whole spectrum of funds is open to you. So let's take a look at the funds which have produced truly spectacular returns over the last five years:

Top 10 Stocks And Shares ISA Funds

Source: Investment, Life & Pensions Moneyfacts. Figures as at 1 February 2008. **= The Specialist sector is a group of funds which invest in various niche areas in different stock markets.

As you can see there are no UK funds here. You'll need to go much further afield to find the top performing funds which all invest in Latin America. The star fund, managed by Invesco Perpetual, invests two-thirds of its assets in the fast-growing Brazilian economy. If you had invested in this fund five years ago you would have made an astonishing return of almost 543%!

But you must remember the caveat: past performance isn't a guide to the future. Funds which invest in Latin America and emerging markets around the world may be doing nicely now but things can go into reverse very quickly. If the fortunes of these economies change, your fund value could soon come crashing down.

What's more, there's no guarantee that a top-performing fund will continue to be run by the same manager, and even if it is, he or she may not do so well in the years to come. So it's hard to know which funds will be the star performers for the next five years. 

If you want to check the past performance of funds, look at Trustnet. However, given the drawbacks of the past performance approach, you may prefer the traditional Foolish solution of investing in a simple, cheap tracker.

And Finally If You're Brave, Self-Select!

If you're a bit of a dab hand at stock picking already you could try a self-select ISA which allows you to choose your own shares and put them into an ISA. If this appeals to you, take a look at The Motley Fool Self-Select ISA where you'll have the option to invest in UK and international stocks at a flat rate cost of just £10 per trade.

*=Source: Investment, Management Association, IMA. Fund statistics - December 2007.

More: Should I Get A Cash Or Shares ISA? | Make The Most Of Your Tax-Free Savings! | Choose an ISA fund at The Motley Fool ISA Centre.