Investors and savers have a fresh ISA allowance to play with for the new tax. Many will be questioning if they are better off putting their money into a cash ISA or a stocks and shares ISA.
The rates on cash ISAs have hit decade highs in recent months. But many of the top deals have been disappearing amid expectations that interest rates have peaked and will be cut later this year.
Many of the top cash ISAs are paying around 5%, which currently beats inflation. It also provides more certainty if you are worried about losses or need access to the cash.
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There is a difference though if you are willing to invest through a stocks and shares ISA. as the returns are likely to be higher over the long-term. If you had money in the average cash ISA over the past 10 years, your tax-free savings would have grown to £1,090, according to analysis by Hargreaves Lansdown, while the same sum invested in a global tracker fund might now be worth £2,243.
“Choosing between a cash or stocks and shares ISA this year is like choosing your favourite child. They both have a lot to offer, but they’re very different beasts,” says Ben Chapman, product manager at Hargreaves Lansdown. “Each one will have their days in the sun and go through some trickier times. And in many cases, the answer is the same as it for many parents: both."
Why you should consider a cash ISA
Cash ISAs may be seen as the poor performing relation of stocks and shares tax wrappers, but they do have benefits.
A cash ISA provides a fixed rate of return, making it easier to plan your finances. Plus there are versions, such as an easy access ISA, that let you withdraw your money quickly and without a penalty. Additionally, the first £85,000 is protected by the Financial Services Compensation Scheme if the provider goes bust.
Some cash ISAs, typically fixed terms, offer rates of around 5%, which does currently beat inflation. This could be beneficial as a home for your emergency savings given the money is instantly available.
Luke Thompson, director at PAB Wealth Management, said a Cash ISA is a “no brainer” for a cautious investor at the moment. “No risk and a return of around 5% with most providers which would be difficult to match for most cautious funds by the time investment charges have been taken,” he says.
“But, if rates fall as predicted this will have an impact for cautious investors as to if it is time to start looking for greater returns via a stocks and shares ISA. At the moment with most cautious investors I am saying leave funds in cash and we will assess as and when those rates start to drop.”
Why you should consider a stocks and shares ISA
The value of a stocks and shares ISA may fluctuate depending on how it is invested, as well as the performance of financial markets.
But, over the longer-term, investing outperforms cash ISAs and typically beats inflation. A stocks and shares ISA may therefore be best if you don’t need immediate access to the money.
Over the past five years, £1,000 invested in a global tracker fund would have earned an extra £833 in a stocks and shares ISA, while in a cash ISA it would have earned £52, according to Hargreaves Lansdown. Over 10 years, the investment would have added £1,243 to your original £1,000, while in the Cash ISA it would have added £90.
The best of both worlds?
It is not just an either or decision when it comes to ISAs. Your £20,000 allowance can be spread across both cash and stocks and shares ISAs and there may be benefits to doing so.
“The choice depends on individual circumstances,” says Scott Gallacher, director at advice firm Rowley Turton. “Short-term funds, like emergency savings, are suited to Cash ISAs, especially instant access ones,” he says.
“Clients with a longer time horizon, around five years or more, and a tolerance for investment risk may find Investment ISAs more suitable. However, for shorter time frames - less than five years- or for those preferring caution, Cash ISAs are often the better option.”
Ultimately, says Chapman, the underlying DNA of each kind of ISA is the same.
“You have a £20,000 you can put into either, the money in an ISA is protected from tax, and you have the flexibility to transfer from one to another or withdraw your cash at any time,” he adds. “However, each has their own quirks.”
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