The value of investments and any income from them can fall and you may get back less than you invested.

Should I invest in an equity ISA or a cash ISA?

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MAKING use of your annual £20,000 ISA allowance is one of the bedrocks of sound financial planning.

 

ISAs can be a highly effective savings tool. They allow your money to grow tax efficiently – you do not have to pay any tax when you make withdrawals or cash them in.

 

Savers can choose between investing the allowance in cash, stocks and shares, or a mixture of the two. Traditionally, in Britain we have shown ourselves to be a cautious bunch, and roughly 75% of all ISAs are invested wholly in cash.

 

In 2017/18, the most recent year for which data is available, the proportion of cash ISAs as a percentage of the total fell from 77% to 72%*. This was as stock markets were doing very well and had been for some time. But given the recent increase in market volatility, it is likely that next year we will see the proportion of cash ISAs creep back up again as nervous savers get the jitters.

 

But are most investors right to take the cash option for their savings? The answer is not as simple as you might think.

 

SHORT-TERM CASH

 

Everybody needs cash savings for an emergency fund and cash ISAs are a valuable tool for holding money that you might need to spend in the foreseeable future, whether for emergency expenditure or for regular, planned outgoings such as school fees. If you need to build up this short-term savings fund, then cash ISAs make sense.

 

LONG-TERM SHARES

 

For those looking for more ambitious returns on their money, and who can afford to commit money for years rather than months, stocks and shares ISAs are the standout choice; history has shown that returns on the stock market far outstrip those achieved by cash over the medium to long term**.

 

This is especially true today, as historically low interest rates make most savings accounts uncompetitive. Indeed, research conducted in October showed that only 27 of the more than 1,000 interest-bearing accounts on the market paid rates that were high enough to beat the rate of inflation and maintain the value of your money***. In all of the UK’s other interest-bearing accounts, savings would be falling in value because the cost of living is rising more quickly than interest rates are adding to your money.

 

For example, according to research by Brewin Dolphin, over the past 10 years, the return on cash after taking inflation into account has averaged -1.36% a year, eroding the value of a £10,000 investment by £1,280.

The annualised return on the FTSE All Share index, however, has been 5.1% over 10 years after factoring in inflation, turning a £10,000 investment into £16,454, and equating to a real profit of 64.5% - over and above increases in the cost of living.

Of course, stocks and shares ISAs are not for everybody. You need to be comfortable with the longer timeframe and the fact that your money can fluctuate in value. Stock-market investing can be a bumpy ride and those with savings in the market over recent months may have seen fund portfolios fall by 10% or more, depending on where it has been invested. It can be a gut-churning experience if viewed day to day and there will be people who are not comfortable with what can be a rocky ride.

 

But for those able to take a long-term perspective, history has shown that share values have outperformed cash over the longer term.

 

*https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/737394/Full_Statistics_Release_August_2018.pdf

 

** Source: E Dimson, PR Marsh and M Staunton, Global Investment Returns Database 2018 (distributed by Morningstar Inc).

 

***Data from Moneyfacts data analysts October 2018