Interest rates may be up, but the cash ISA is still not king

The Bank of England moved interest rates up to 0.5% in November 2017, the first rate rise for 10 years, but account providers have been slow to improve saver returns. Cash continues to be a wasting asset class in an inflationary environment.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results
Interest rates

The ISA tax wrapper allows you to save and invest, tax free, in both cash and equities and funds. Over the long run, this should prove to be a very powerful way to grow your wealth. 

Cash ISAs were introduced in 1999, with an annual saving limit of £3,000. Eighteen years later, the allowance has been raised to a very accommodating £20,000 for 2017/18.

Nevertheless, it is an astonishing fact that a saver getting the UK base rate return of 5.25% in April 1999, would have received 57% more tax free income from their £3,000 (£157.50 of interest) than someone saving £20,000 today at 0.5% (£100 of interest).

Since the financial crisis, cash returns have been miserly (see Image 1). This is because central bank policy has deliberately kept interest rates low to boost consumption, and to generate economic growth. Savers have been punished for their frugality, while those with assets, and those borrowing to invest in assets (e.g. housing) have been rewarded with large returns.

A combination of stagnating real wages, and moribund returns on cash deposits, has been a very unrewarding environment for increasing your wealth.

Image 1: UK Base Rates vs. RPI Inflation

The latest tables for instant access cash ISAs from little to improve the outlook. Top billing goes to the AA, offering 1.06% inclusive of a 0.86% fixed bonus for 12 months. In second place is Skipton Building Society offering 1.02% (including a 0.27% bonus), while Ford Money (1%) slots into third place. Of the major providers, Nationwide offers 0.5%, and NatWest brings up the rear with a paltry 0.01% rate of return.  It appears that the majority of Cash ISA providers have not passed the 0.25% rate increase onto the consumer.

If you opened the highest returning cash ISA – even when it offers a greater return than the Bank of England base rate – you would still guarantee to lock in a loss in real terms, after inflation has been taken into account.

Read more: How inflation is killing your cash savings

What are the alternative options?

The real question is whether you need large cash deposits at all?

Holding a few month’s cash is certainly important to stave off life’s unwelcome emergencies; job losses, replacing the boiler, fixing the car etc. But deliberately holding large sums of cash over the very long run – it would have been possible to have saved £121,000 in a cash ISA since their launch - is overly cautious and faces significant risk of erosion from inflation. Ultimately, a focus on avoiding short-term losses increases your chances of not having enough money to meet your long term goals.

There is also the opportunity cost to consider; what could you have invested in over the long run which could have made you larger returns? 

By not investing in equities, a long term cash saver is effectively doubting mankind’s ability to continually adapt to its surroundings, to generate growth where it seemed doubtful before, and to share the proceeds of growth amongst its shareholders. Over rolling five year time periods it is rare to lose money in equities, but it is admittedly still risky to invest everything at once. 

A slow drip feed into the market, known as pound cost averaging can help smooth your returns while also eliminating the chance of investing everything at the top of a market. Innovation in the past five years has made it easier (and cheaper) to invest small sums of money on a regular basis.

IG Smart Portfolios have been designed to invest your money securely over the long term, in a series of portfolios which take on different amounts of risk. And, unlike fixed term cash ISAs, there are no exit fees if you want to sell. If you invest today, and change your mind tomorrow, your investment will be returned to you. 

1As of 6 November 2017

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