Is It Time to Ditch Your Cash ISA?
Since their introduction in 1999, the Individual Savings Account (ISA) has been a huge success. Replacing the ‘Personal Equity Plan’ (PEP) and ‘Tax-Exempt Special Savings Account’ (TESSA), in essence, an ISA is a tax-free savings and investment plan allowing individuals to grow their money without paying any income tax or capital gains tax.
Since their introduction, the amount invested in ISAs has mushroomed as people warmed to the tax-free status they enjoyed as well as (in most cases) retaining complete access to their money (unlike investing in a pension).
Up until recently, there was a distinction between ‘cash ISA’s’ and ‘stocks and shares ISAs’. The rules have since been merged and the ISA family has grown to include the ‘Help-to-buy ISA’, ‘Lifetime ISA’, ‘Innovative Finance ISA’, ‘Junior ISA’, ‘Flexible ISA’ and ‘Inheritance ISA’. Without going into the technicalities of the differences, many people still understand that they can use their ISA for cash (effectively a bank account) or an ‘invested’ ISA that uses funds or stocks to provide an investment return.
Cash ISAs became incredibly popular early this century and their popularity shows no signs of abating. Today, there is more than £250bn invested in cash ISAs in the UK. In early 2001, some cash ISAs were offering a rate of 7.25% with investors able to contribute up to £3,000 a year. A fully funded ISA would earn £217 a year – a healthy return with almost no risk at all.
Today, those rates seem a world away. Even the best instant access ISAs are now giving savers less than 1% a year. And that’s the best ones – the worst are barely paying any interest at all. This means the very best return on that same £3,000 is now around £25 a year in interest.
What is surprising is that although interest rates are at rock bottom, flows into cash ISAs continue apace. Since 2001, ISA limits have increased and today, savers are able to put away £15,240 (rising to £20,000 after April) a year. Many savers have religiously put their savings into an ISA year after year and could be sat with tens of thousands of pounds in their cash ISA.
Inflation destroys returns
Today, inflation in the UK stands at 1.8% meaning even the best cash ISA will be likely to lose money in real terms. With the recent fall in Sterling against other currencies, inflation expectations are in the 3-4% range over the next couple of years. If ISA rates don’t pick up (and there is little sign they will), savers could be losing 2-3% a year. Someone who had amassed £30,000 in cash ISAs could be losing £1,000 a year just by holding money in a cash ISA.
Savings versus investing
Most people are comfortable with ‘saving’. Risk-free, simple and easy to understand. ‘Investing’ is seen as complicated, risky and difficult – but it needn’t be. Everyone should have some savings. Savings are crucial to pay for unforeseen emergencies like losing your job or if you are likely to need your money in the short term (less than 5 years). For those who are putting their money away for the longer-term, they should probably be ‘investing’, not ‘saving’.
Investment markets rise and fall and aren’t right for everyone, but the reality is that the only real way to make your money grow (or even stand still) in an ISA today is to invest, not save.
If you are unsure about whether you should invest and how best to do this, you are best off speaking to a chartered financial planner or other independent expert.
So what are your options?
ISA’s can be consolidated and transferred into an alternative ISA at any time. No longer are ‘cash ISA’s and ‘stocks and shares ISAs’ kept separate. This means you can invest when you need to and save when appropriate.
One option is to transfer some of your cash ISAs into investment funds. You don’t need to take on a massive around of risk – just enough to get your money growing. A financial planner can help assess your attitude to risk and create a diversified portfolio that should minimise the downside as well as providing growth when investment markets rise. Depending on the amount of risk you are willing to take, an average annual return of 5%-8% is realistic, but remember, you will have times when your investment falls in value so you need to always think long-term.
Another option is an ‘Innovative finance ISA’. This means you effectively lend your money to borrowers through what is known as ‘peer-to-peer (P2P) lending’. This is a relatively new form of financial product so the market is still developing and risks being assessed. While not risk-free, the risk may be lower than putting your money in some investment funds, with returns likely to be in the 4%-6% range. You can still lose money but, as you lend to a wide range of borrowers, the risks of significant defaults (losses to you) are minimal.
Get an ISA boost
Whatever you invest in – cash, investment funds or P2P lending, from April 2017, many people will be able to take advantage of the new ‘Lifetime ISA’ (LISA). This type of ISA comes with a free government top-up (free money!) but also comes with some significant health warnings; it and may actually end up costing you money, not making you money. As usual, the devil is in the detail and the pros and cons need to be weighed up carefully.
ISAs are a great way to save and invest, but the range of different ISAs and different investment options can be confusing. Seeking expert independent advice can help you clarify your options and work out what is best for you. If you have savings sat in a cash ISA, there has never been a better time to take a long hard look at it. Think carefully about what you are trying to achieve and understand that holding significant amounts in cash for the long-term is unlikely to be a good strategy.
Your cash ISA is almost certainly losing you money. That is not in question. The question is – what are you going to do about it? Talk to an independent financial planner and discuss your options. Don’t watch your money go down the drain. Take action now to make your money work as hard as you do.
If you want to talk through your ISA options, please contact us to arrange a free consultation.