Cash ISA versus Stocks and Shares ISA
It can be tricky to work out how to organise your investments to make the best use of tax allowances and optimise returns.
If you are thinking about opening an ISA or topping up your current ISA, you are likely to face a decision over whether to go for stocks and shares, or cash, or a bit of both.
Your total annual tax-free ISA limit is £20,000. You can invest some in a Cash ISA and some in a Stocks and Shares ISA – it doesn’t have to be one or the other. You can also invest some of your allowance in a Lifetime ISA (if you are eligible) or an Innovative Finance ISA.
When choosing the best ISA for you, the choice you are making is really a choice between lower risk and lower returns or higher risk and potentially higher returns.
Cash ISAs are lower risk, while Stocks and Shares ISAs tend to be higher risk, because their performance is dependent on the performance of individual stocks or an index.
However, you are also choosing what proportion of your pot you would like to invest in each type, which will depend on many things, including your goals, the length of the term you wish to invest for, your views on the markets, the economy and the outlook for interest rates, and your risk profile.
It's really a choice between lower risk and lower returns or higher risk and potentially higher returns
Banks and building societies offer Cash ISAs, which are tax-free savings accounts. Since the introduction of the Personal Savings Allowance of £1,000 tax-free interest for basic rate taxpayers and £500 for higher rate taxpayers per year, the need to use a Cash ISA for people wanting tax-free savings has diminished – as all savings accounts, regardless of whether they are an ISA, offer tax-free interest up to these limits.
Savings accounts of all kinds have the advantage of deposit protection, should the bank or building society go bust, up to the Financial Services Compensation Scheme limit of £85,000. For investment accounts, the limit is lower, at £50,000, if the provider goes bust. However, the interest rates currently on offer on Cash ISAs could make them less appealing. Rates are around 1 to 2 per cent, and so do not match the current rate of inflation.
If you want the higher potential returns on offer from the stock market (the value of the FTSE 100 is about 15 per cent higher than it was 5 years ago), you can get Stocks and Shares ISAs from investment platforms, like EQi.
It is important to remember that within a Stocks and Shares ISA, you can still choose funds that are lower risk and produce an “income” from dividends, which is a bit like receiving interest because they are regular payments, although the level can vary.
Lower risk funds tend to invest in more mature, established companies with relatively dependable profits and decent historic dividend payments. However, they may not be as likely to produce capital growth as a fund that is focused on rapidly growing companies or sectors.
If you would like to allocate some of your money to higher growth prospects, you can do this within a Stocks and Shares ISA, too.
The only limit to the number of funds or stocks you invest in through a Stocks and Shares ISA is the amount of money you have to invest (and how much you are prepared to pay in charges for buying and selling) – meaning there is lots of potential to diversify.
So you can diversify between different types of ISA (Cash or Stocks and Shares) and within the Stocks and Shares ISA itself.