Stocks and shares beat cash ISAs despite high interest rates

Cash savers have enjoyed rising interest rates over the past two years, with savings rates hitting a 15-year high.

This has encouraged record amounts of money to go into cash ISAs. Analysis by the Bank of England shows net inflows of £12.3 billion went into cash ISAs in April 2024, the highest inflow since 1999. This was followed by a record month of net inflows for May at £4.2 billion, the highest May figure on record.

But while the returns on cash ISAs and savings accounts have increased, they have been no match for stocks and shares ISAs investing in UK or global equities.

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This is the finding of recent analysis by investment platform AJ Bell on behalf of MoneyWeek. This reveals that while the average cash ISA paid 2.7% last year, a stocks and shares ISA investing in global equities returned 12.7%. Meanwhile, an ISA invested in a UK equity fund returned 7.4% on average.

When inflation is taken into account, cash ISA customers were sitting on a loss, with a real return of -1.2%.

“Cash rates are much better than they were, but despite rising interest rates the average cash ISA has still returned much less than the stock market over the last year, and has actually gone backwards once inflation is factored in,” comments Laith Khalaf, AJ Bell head of investment analysis.

Over longer periods, the gap between cash returns and investment returns becomes much bigger. 

Over five years to the end of 2023, the average cash ISA returned 5.5%. But a stocks and shares ISA holding the average global equity fund grew by 65.7%. An ISA holding the average UK equity fund returned 31.6%. 

Over 20 years, the average cash ISA returned 53.4% to savers, while an investor in the average global equity fund would be sitting on a massive 395.8% return. Someone holding a typical UK equity fund would have a 257% return.

How have these figures been calculated?

We asked AJ Bell to crunch some figures showing how a typical cash ISA would have performed against the average stocks and shares ISA.

We used the average cash ISA as recorded by the Bank of England. Of course, some savers would have found a higher-paying cash ISA than 2.7%, the average rate for 2023. According to our best-buy tables, the top-paying easy-access cash ISA currently pays 5.2%. 

But, some cash ISA customers would have had a lower rate than 2.7%, especially if they hadn’t looked at their account for a while and switched to take advantage of a better deal.

In terms of stocks and shares ISAs, AJ Bell looked at global equity funds and UK equity funds, as it said “these are by far the most popular two sectors held by UK retail investors”.

How cash ISAs and stocks and shares ISAs compare

While most of us know that investments generally perform better than cash over long timeframes, it’s surprising that cash ISAs underperformed last year given the backdrop of rising interest rates. 

Sources: AJ Bell, Bank of England, ONS, FE total return data to 31 December 2023.

It’s worth noting that investors who chose to focus on one region or sector may have had a different experience last year, and may be sitting on some painful losses. 

This would have been the case for someone who invested solely in the China/Greater China fund sector. According to Moneyfacts, this was the worst-performing stocks & shares ISA fund sector last year, falling by more than 30%. 

The commodities and natural resources sector also fared badly, falling by almost 13%.

How inflation erodes returns 

Inflation may be coming down from its double-digit peak - it was 2.0% in the 12 months to May - but it can still erode returns.

“If you hold large sums of cash for long periods you open yourself up to the risk of inflation eroding your spending power, and falling behind those who invest in the stock market. The stock market has ups and downs so you need to be willing to ride out the rough with the smooth, but the quid pro quo is that you are likely to beat cash and inflation in the long run,” says Khalaf. 

He adds: “Data from Barclays going back to 1899 shows that over a 10-year period UK shares have beaten cash over 90% of the time. Moreover, cash produced negative real returns in six of the eleven decades between 1912 and 2022.”

What’s best for me: cash ISA or stocks and shares ISA? 

While our analysis shows that you could have grown your money much more with a stocks and shares ISA over different time periods, the truth is you need to be comfortable with the risks of investing, and also consider your goals and time frame. 

Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners, the wealth manager, says: “When it comes to choosing between a cash ISA and a stocks and shares ISA, deciding where funds should be placed should be guided by the time horizon and when you need the money rather than how the markets or savings rates are performing at a particular point in time.”

Money that is needed in six months or 12 months’ time for a short-term savings goal, such as a holiday, wedding, or big-ticket purchase, would be better placed in an easy-access cash ISA to ensure you can withdraw it quickly when needed.  

“But funds not needed for five years or more - whether to pay for retirement, a child’s university costs or a deposit on a first home - can benefit from the compounding effect that comes with investing money over the long term,” says Haine.

She adds that with interest rate cuts expected this year, savings rates are likely to retreat in the coming months, and so “hunting out the best [interest rate] for those with short-term savings goals will remain key, while those with long-term goals should stick with a stocks and shares ISA”.

You can choose both types of ISAs, dividing the £20,000 tax-free annual allowance as you wish. For example, you could pay in £5,000 to a cash ISA and contribute £15,000 to a stocks and shares version.

Don’t forget to check your investment holdings - or your interest rate if you have a cash ISA - to make sure it’s competitive.