Why you should swap your cash ISA for a stocks and shares ISA
With inflation outpacing typical interest rates, your cash savings are eroding in value in real terms. As the ISA allowance hits £20,000 per year, it’s a good time to consider a stocks and shares ISA instead.
Since it was first introduced in 1999, the cash individual savings account (ISA) has become the saver’s account of choice thanks to its long-term tax-free status and its rocketing annual allowances. But as the ISA allowance goes up to a whopping £20,000 this tax year, it may be time to swap your cash ISA for something a bit more adventurous.
Why not invest in a stocks and shares ISA instead? You can use some, or all, of your allowance to invest directly in assets like shares and bonds (corporate and government) or to buy funds that invest in these assets on your behalf.
While investing in stocks and shares is a riskier enterprise than sticking with cash, there has never been a better time to take the plunge. The average interest rate on cash ISAs has plummeted in the last decade, from an average of 5.06% to just 0.82% today. Our banks and building societies simply aren’t incentivised to draw in deposits to keep their balance sheets ticking over, as they can dip into the Bank of England’s (BoE) Term Funding Scheme instead.
Inflation is outpacing interest rates
Inflation is running high after the pound sunk in result of Brexit, with the consumer price index shooting up to 2.3% in February. The current crop of cash ISAs pay nowhere near this much in interest, making it impossible to maintain, let alone grow, the real value of your money.
What’s more, cash ISAs no longer offer as much of an edge over standard savings products. A decade ago, you could earn almost twice as much in a cash ISA but today, many long-term bonds are offering at least 1.3%, with interest likely to be tax-free since the personal savings allowance was introduced last year. This gives a basic rate taxpayer the chance to earn up to £1,000 on standard savings accounts and current accounts without any tax liabilities (it’s £500 for a 40% taxpayer and nothing for a 45% tax payer).
So why let your precious ISA allowance slowly erode in cash when it could be put to work in the stock market instead? Any returns you earn from equities are free from capital gains tax and all interest from corporate bonds also avoids income tax. What’s more, you can shield your dividends from HM Revenue & Customs under the dividend allowance, which currently stands at £5,000. Considering how much you could potentially make on your investments, the tax benefits of the ISA wrapper are far more impressive on stocks and shares than cash.
The average stocks and shares ISA fund has grown by 15.8% during the 2016/17 tax year so far — the highest return in seven years. The best performing sector for ISA investors was Japanese Smaller Companies, returning a healthy 40.1%, while the best performing individual fund was JPM Natural Resources, posting a return of 55.5%.
Stocks and shares have historically outperformed cash over longer-term
You can invest as much or as little of your allowance as you like, depending on whether you can afford to lose money in the worst case scenario and what your appetite for risk is. While there are no guarantees that you will make money on stocks and shares, history shows that investing for at least five years usually beats the interest you earn on cash.
The longer you are invested, the riskier you can go, with a greater stake in equities compared with bonds, and the more likely you are to grow your money. This gives you enough time to ride out the natural highs and lows of the market. The average stocks and shares ISA has delivered positive growth in 11 out of 18 tax years since the introduction of ISAs in 1999. This tax year, just 33 out of 979 funds (3%) have lost money.
Remember that the performance of your portfolio will go up and down, and the past is not a completely reliable indication of the future. But as long as you are invested for the long-term, diversify your portfolio and hold your nerve during market wobbles, switching into stocks and shares could be one of the best financial decisions you make.