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Europe hasn’t bothered me much these past few years – unless you count my terror this summer when I was quizzed by a tussle-haired French waiter in jeans (even scarier than the old-fashioned variety) in a hip Parisian eatery ¹.

No, I’ve carried on investing despite more prophecies of doom than you’ll find in a Tolkien trilogy.

That’s not to say Europe’s problems aren’t immense. However:

• I wasn’t surprised by them, because I never supported the Euro. It’s the flaws of the original currency union – not the particulars of any one country – that are ultimately threatening Europe.

• I believe it’s in Germany’s interest to save the Euro, and that it can do so.

• I can’t do anything about it, anyway.

But my measured bonhomie towards Europe’s woes was pushed to breaking point this past week.

First Italy’s Silvio Berlusconi turned away the IMF because the restaurants in Rome were full (really). Then he didn’t quit when I bet he’d have to. Next Italian bond yields soared after margin requirements by a key broker were increased – and the ECB at first stood by and did nothing. Finally, numerous ECB officials ruled out intervention by Europe’s Central Bank.

Meanwhile the idea of Greece leaving the Eurozone began to be discussed as a plausible option by the core decision makers. Greece doesn’t matter much – it amounts to 1% of European GDP, and most of its debt has already been written down – but the dangers of precedent setting loomed large.

I was so bothered that I finally sold out of some of my defensives in the trading portion of my portfolio on Tuesday. They are well up over six months and didn’t look likely to go much higher in a surprise rally, and I wanted some cash to buy bargains in a rout.

Happily, however, Europe, the ECB, and me all stepped back from the brink.

Berlusconi got the boot in Italy, austerity measures were approved, and a new technocratic government is on the way. Germany’s big bluff against Greece worked, too – it called off its referendum and it’s getting a wise council of wonks to push through reforms.

Best of all, the ECB stepped back into the bond markets and pulled the Italian 10-year bond rate well under 7% again. Having proved it can do it once, the clamour for it to do so again will surely be irresistible.

On Friday morning I bought back in with the cash I’d raised, roughly equal on the deal and without tax consequences thanks to glorious ISA protection.

I still believe market timing is a mug’s game, incidentally, even though being more active has helped me over the past 3-4 years. Regular meddling looks clever until a big surge one way or the other wipes out the profits you made (after expenses) by fiddling – and that’s assuming you’re even good at it in the short-term, which most people aren’t.

I far prefer to remain invested at all times (though I actively tinker with asset / geography / sector allocation, even in my passive portfolio). My going part-liquid on Tuesday was a measure of how much risk Vs. reward had finally tilted for me.

Now I’m back to a watchful vigilance. While I read as much about Europe as the most avid doomster, I still believe this sort of drama is more likely to yield opportunities for equity investors with a sufficient time horizon. Time will tell.

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1. Sorry, there is no other word for this place.[↩]

We’ve previously compared ETFs ¹ against index funds on the basis of:

• Simplicity
• Costs
• Tracking difference (aka tracking error)

Now we consider choice, and after two losses and a draw, it’s here that ETFs finally land a blow against their index fund brethren.

There’s simply much more choice when it comes to ETFs, especially if you want to invest beyond the major indices.

Indeed, sometimes you’ll have no choice but to pick an ETF if you want to track certain asset classes. As I write, there is no index fund aimed at UK investors that covers:

• Property
• UK Small Cap
• Value
• Commodities

So if you want a diversified portfolio that includes any of those asset classes, ETFs will have to be part of your mix.

Too much ETF choice?

The ETF population has exploded over the past ten years like rabbits bounding over virginal Australia. They’ve burrowed into almost every conceivable market niche – and yet still the financial engineers keep tinkering and dreaming of new ones!

You want to track a Christian friendly index, or a fish food benchmark?

You can!

You want to bet on the prospects of renewable energy?

You can with ETFs – but not with index funds.

Of course, once you step off the broad avenues of the main indices, you can find yourself up some pretty dark alleyways that harbour all kinds of exotic offerings. Make sure you keep your wits about you.

Also, keep in mind that not all things with ET in the title work in exactly the same way. For example Exchange Traded Commodities (ETCs) are a quite different barrel of fish.

Take it steady,

The Accumulator

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1. Exchange Traded Funds.[↩]

Thanks to the currently high rate of inflation, the 2012 ISA allowance has been increased quite a bit above last year’s level.

The 2012 ISA allowance is £11,280.

This means that between 6 April 2012 and 5 April 2013, you’ll be able to put up to £11,280 into your ISAs – and so out of the reach of the taxman!

Note: The ISA allowance is the amount of new money you can put into an ISA over the year. If you already have ISAs with funds in them from previous years, that money doesn’t count towards the new annual ISA limit. Only new money does. This way you’re allowed to build up an ever-bigger ISA pot over time.

As always, up to 50% of your total ISA allowance can be put into a cash ISA. This means the 2012 cash ISA allowance is £5,640.

The total you can put into a stocks and shares ISA is £11,280 minus whatever you will put into a cash ISA that year.

For instance, if you choose to put £2,000 into a cash ISA over the 12 months to 5 April 2013, then you could put £9,280 into a stocks and shares ISA that same tax year.

On the other hand, if you don’t put any money into a cash ISA, then you have the full 2012 ISA allowance free for shielding more of your equities and bonds from tax by moving them into an ISA ¹.

How to use your ISA allowance

Only higher-rate taxpayers pay tax on share dividends, whereas income from cash, corporate bonds and gilts is taxed for lower rate and higher rate taxpayers alike.

This means most lower-rate tax payers owning bonds should put them in an ISA first, and then put dividend paying equities in after that if they have any spare ISA allowance leftover.

Higher rate taxpayers should put whatever they can into an ISA. You might put your highest yielding shares or bonds into an ISA first, to protect the income they pay from tax. (The effective tax rate on share dividends is lower than on bond income, though, so do your maths).

Even if you’re a lower rate taxpayer and you own no bonds, I’d still put your shares (whether directly owned shares or shares held in an index fund or similar) inside an ISA wherever you can.

This is to avoid you building up a capital gains tax time bomb, which can really take the shine off selling your shares for a profit in a few years time!

What’s more, you might become a higher rate taxpayer in the future.

2012 ISA allowance and CPI inflation

The ISA allowance only began going up with inflation in March 2010, when the government raised the annual allowance by £3,000 to £10,200 for the 2010-2011 tax year.

At the same time, the then-chancellor Alistair Darling also announced the annual ISA allowance would go up every year by the RPI inflation rate in September of the prior year, rounded to the nearest £120.

However no government seems to like allowing us to pay less tax, especially in times of austerity. Accordingly, the current chancellor George Osborne is only raising the 2012 ISA limit by the CPI inflation rate, which is typically lower than the RPI inflation measure.

CPI inflation was 5.2% as of the official September figures. RPI inflation was running at 5.6%!

At least the rounding procedure has worked in our favour.

The 5.2% inflation rate should have meant the new limit was £11,235. But rounding to the nearest £120 takes us higher to £11,280.

Monthly savings into an ISA

Rounding to the nearest £120 is designed to make it easier for us to set up monthly savings.

Dividing the 2012 ISA allowance by 12 months gives us a saving target of £940 a month, which is quite a substantial amount for most people to save from their earnings.

One way to use it up is to sell any non-ISA-d investments that you’ve got that can be moved into an ISA. (I’ve been doing this for years, having foolishly not bothered with ISAs (or their predecessors, PEPs) in my early years of saving).

If you’re thinking of funding your 2012 ISA allowance with share sales, then read my article about defusing capital gains tax on shares for some pointers on how best to sell.

1. Note that when I speak of moving shares and bonds into an ISA here (and in the rest of the article) I mean selling them, putting the money raised into an ISA, and then repurchasing. Unfortunately you cannot transfer shareholdings into an ISA directly to avoid these transaction costs.[↩]