When it comes to Isa savings the vast majority of us prefer to invest in cash rather than in stocks and shares.
Statistics from HMRC show that £39 billion was deposited in Cash Isas in the 2016/17 tax year compared to just £22 billion in investment (also known as Stocks and Shares) Isas.
But, with interest rates on Cash Isas pitiful, is it time we looked beyond the easiest option in order to make our savings work harder?
If you are looking for a Cash ISA to save in at the moment, the best possible interest rate you can get is 2.25%, and to get that you need to lock your money away for five years. But, if you look at alternative Isa options you could more than double that return. Of course, this does mean being comfortable increasing the level of risk too.
Invest in the stock market and you might get a return of 7.5% - that’s how much the FTSE 100 has risen by over the past five years). Look beyond the FTSE 100, and there are investments you can hold within your Isa that are offering even bigger returns. For example, a small cap fund such as, Marlborough UK Micro-Cap Growth Fund – a Moneywise First 50 funds for beginner investors – has delivered 39% (discrete) growth over the past five years.
A spokesperson for financial provider Wellesley comments: “With Cash Isas no longer offering an edge over standard savings products, now is the time to consider testing out what Stocks and Shares Isa have to offer. Historically, Stocks and Share Isas have outperformed Cash Isas when it comes to offering a more attractive rate of return, and this is not expected to change any time soon.
“Stocks and Shares Isas can also enable you to grow your portfolio at a faster rate, in addition to offering access to alternative investment opportunities. The end result? You should achieve a higher rate of return and a more diversified portfolio.”
Another option is to open an Innovative Finance Isa. These allow you to hold peer-to-peer investments in an Isa wrapper, so your returns are tax-free. Numerous providers now offer IF Isas with returns of up to 16% available.
How to utilise a Stocks and Shares Isa
It’s a good idea to always keep some of your savings in cash, that way if there is an emergency you can easily access your nest egg. But, it isn’t a wise strategy to leave too much of your savings in cash, as it could be earning you a better return elsewhere, especially if you can afford to lock it away for a while.
“Everybody should keep some money aside in accessible cash savings,” says Patrick Connolly, a certified financial planner at Chase de Vere. “Stocks and shares Isas are the choice for most long-term investors. There are a wide range of stocks and shares investment options and through the use of platforms, many different funds and asset classes can be held within the same Isa if required.”
If you are considering putting your money into an investment ISA then your first aim may be to build an investment portfolio that offers you better returns than available on cash savings, but with minimal risk. This is what Sarah Coles, a personal finance analyst at Hargreaves Lansdown, calls the “vanilla core of a portfolio”.
“For most people, the right Isa strategy is a plain vanilla one. It’s important to build up a sensible core of mainstream funds, designed to grow over time without taking excessive risk.”
This may be an investment portfolio of government bonds, corporate bonds, and funds investing in blue-chip stocks.
“However, investors who have already established the plain vanilla core of their portfolio, might want to add more exotic options with the potential to grow at quite a lick,” says Mrs Coles. “Of course, this comes with additional risk, which is only going to work for investors with more adventurous tastes, and for those with an investment horizon of at least 10 years.”
Many people don’t realise just how broad the range of assets is that you can hold within an investment Isa. Alongside, bonds and FTSE funds you can also hold shares from any recognised global stock market, including AIM (Alternative Investment Market), and exchange traded funds (ETFs) which track particular markets, commodities, assets or currencies. This means you can gain exposure to small companies, precious metals and foreign currencies all with the tax-efficient benefits of an Isa.
“There are plenty of adventurous options for those who are prepared to take more risk,” says Mrs Coles who suggests you could gain exposure to the growth potential of emerging markets with the JPM Emerging Markets fund. You could also opt to hold some smaller companies with the potential for faster growth.
How IF Isas work
But it isn’t just investment Isas that offer potentially greater tax-efficient returns than the nation’s favourite Cash Isas. You could also consider investing in an Innovative Finance Isa (IF ISA). These allow you to put your money into peer-to-peer investments within the tax-efficient wrapper of an Isa.
“Stocks and shares Isas can be especially volatile, as illustrated by the recent tumble in global markets which saw the worst fall in value for six years,” says Andrew Lawson, chief product officer at peer-to-peer platform Zopa. “While Cash Isas offer security but low returns in the current savings environment.”
As such, an IF Isa can be seen as a half-way ground, in terms of risk, between an investment Isa and a Cash Isa.
“IF Isas offer a great option for anyone looking to boost their Isa returns by investing in assets with potentially higher returns than cash, but without the volatility of shares,” says Rhydian Lewis, chief executive and founder of peer-to-peer platform Ratesetter.
Anyone thinking of investing in an IF Isa does need to be cautious though. Firms offering them have to be regulated by the Financial Conduct Authority, but they aren’t covered by the Financial Services Compensation Scheme. This means if the firm goes bust you may not get your money back.
Since the introduction of IF Isas numerous companies have jumped on the band wagon offering very alluring rates of interest of up to 16% a year in some cases. But, remember the rule of investing - the higher the return the higher the risk. With an IF Isa you are lending your money and there is always a chance that either the borrower won’t repay your money or the company you are lending it through could go belly up.
So, be cautious and do your research before investing in an IF Isa.