Should you invest your Isa cash for better returns?

If you have five years or more in which to invest your money and you are prepared to take some risk, then this type of Investment Isa could be the right choice for you

Savers have gradually been turning their backs on Cash Isas and opening Stocks and Shares Isas instead. The number of new Cash Isas opened has fallen each year since 2013-14, according to HMRC. Back then, 10.4 million Cash Isas were opened, but by 2017-18 the number had fallen to just 7.7 million.

Saying that, savers still shovelled as much as £39.8 billion into Cash Isas during the 2017-18 tax year.

Interest paid on Cash Isas rarely beats inflation these days, making it hard to grow your pot. Another factor is that the personal savings allowance (introduced in April 2016) means basic-rate taxpayers can earn up to £1,000 interest a year tax-free, while higher-rate taxpayers £500. This tax break (which is not available to additional-rate taxpayers) could be a reason Cash Isas have become less appealing to savers.

Either way, an increasing number of savers are turning to Stocks and Shares Isas in search of better returns. The number of new accounts opened has been steadily rising since 2015-16, with 246,000 new subscribers in the 2017-18 tax year.

Are you ready to invest in the stock market?

A Stocks and Shares Isa is one of the easiest and cheapest ways to invest. Stock market investments tend to go up in value over the long term but can experience volatility where the value rises and falls over the short to medium term.

This is one reason why it is best to invest only if you are planning for the long term – that is, for at least five years.

It also makes sense to build up a cash buffer for life’s inevitable emergencies first, before locking up cash in investments. As a rule of thumb, it is wise to have three months of outgoings held in cash – just in case.

Once you have this in place, you could consider investing.

Why use an Isa?

There are several taxes associated with investing, but a Stocks and Shares Isa shelters your money from all of these.

First, some investments pay interest, such as government and corporate bonds or rental income from some property funds. There is no tax to pay on this income if the investments are held in a Stocks and Shares Isa.

Second, any dividends paid by your investments are tax-free if held in an Isa. The annual dividend allowance for investments not held in an Isa is £2,000. This allowance was cut from £5,000 in the 2017-18 tax year, making it even easier to be hit by the tax if you don’t use an Isa.

Third, an Isa shields your investments from capital gains tax (CGT) on your investment growth. CGT is payable on investments that have increased in value when you come to sell, on anything over £12,000.

Money saved in a Stocks and Shares Isa is protected by the Financial Services Compensation Scheme (FSCS) up to £85,000 in the event of an investment product provider going bust. However, it usually does not cover losses from the underlying stock market investments.  

 Is it very different to a Cash Isa?

Moving from building up a nest egg in a Cash Isa to putting money in a Stocks and Shares Isa can be quite a transition.

With a Cash Isa, you know exactly how much money you have and can expect to have at any one time.

But the value of a Stocks and Shares Isa can change from one day to the next. You can check its value at any time. If you do so regularly, you will see that the value of your investment can go up and down significantly over the short term. But, hopefully, over the long term, your investments will increase in value.

How do you open one?

Opening a Stocks and Shares Isa has never been easier.

You will need to pick an investing platform to buy your Isa from and then decide what investments to put in it. Charges will vary depending on both the platform you choose and the investments or funds you pick.

Experienced investors might opt for a platform where you choose investments – such as equities, bonds, and funds – yourself. Other providers offer ready-made portfolios with different risk levels. In general, the more risk you take, the higher the potential returns. However, there is also a higher chance you will lose money.

Pick a platform that allows you the type of control you are after,  offers good customer service, and allows you to buy the range of investments you want.

For beginner investors, Moneywise recommends using funds as these allow you to spread your risk – or diversify – across a greater number of holdings.

Many investing platforms have recommended lists of funds, which can be a good starting point. Moneywise also has a list of First 50 Funds for Beginners, which we believe can form the basis of a good portfolio for first-time investors.

How much will I pay in fees?

One of the most crucial factors to consider is price. Examples of major platforms include AJ Bell Youinvest, Charles Stanley Direct, Hargreaves Lansdown and interactive investor (Moneywise’s parent company). Each charges a platform fee, which is usually a fixed fee or a percentage of your Isa’s total value.

On top of that, the company or companies running the funds you pick will charge you a separate fee.

Costs can quickly erode your returns – for example, an extra percentage point paid in fees can cost you tens of thousands over the long term.

Are there other alternatives?

Lifetime Isas are another way of investing, but are only suitable for people saving toward their first home or retirement. Read pages 8-9 of this guide to see how they work.

Innovative Isas are the newest type of Isa and, since 2016, have allowed investors to hold peer-to-peer (P2P) investments within an Isa. These can offer considerably higher returns than Cash Isas, but they also come with greater risk.

Your cash is at risk if the platform goes bust and you are not protected by the FSCS as you would be with a Cash Isa. However, some platforms have their own safeguards and provisions in place.

Last year saw two P2P lenders, FundingSecure and Lendy, collapse and investors lose money.Consequently, the Financial Conduct Authority introduced new P2P lending rules. Investors now cannot place more than 10% of their assets in P2P investments unless they have received financial advice.

However, the cap does not apply to high-net-worth investors.