ISAs come in many guises. There’s Junior ISAs (JISAs) for those under 18, Help to Buy ISAs for first-time buyers, Innovative Finance ISAs for people using Peer to Peer lending platforms and the Lifetime ISA for people saving for later life or a house deposit. The two most common types are Cash ISAs and Stocks and Shares ISAs (or Investment ISAs as they are also known). Both have pros and cons, and which is most appropriate for you will depend a lot on your circumstances.
Cash ISAs tend to be the default choice for most Brits, with around 11 million accounts held in the UK, making up almost 80%* of all ISA subscriptions. The key feature of Cash ISAs is they give you a guaranteed rate of return, so you know exactly how much your money will grow each year. While promotional rates for Cash ISAs can be attractive, they can drop once your introductory period ends. Higher returns are typically available via fixed rate deals, if you don’t mind tying up your money for up to 5 years, but they’re unlikely to be suitable if you think you might need to access your cash in the meantime. If you think a Cash ISA is for you, search for a rate that’s above inflation, or you risk your money not growing in real terms. Also, remember the new Personal Savings Allowance was introduced in 2016 that allows basic rate tax payers to earn up to £1000 of savings income tax-free, so it’s worth considering whether you need a Cash ISA at all. The good news is, if you decide a Cash ISA is for you, they’re really quick and simple to set up and you won’t typically pay any fees.
Stocks & Shares ISA
Stocks & Shares ISAs (or investment ISAs) don’t give you a guaranteed annual return, and you can get back less than you originally put in. This is because your money is invested, rather than being held as cash by the bank. Stocks and Shares ISAs can be used to invest in a multitude of things, including equities (company stocks) bonds, or investment funds such as trackers and ETFs. Whilst they’re more risky than Cash ISAs, the trade-off with a Stocks and Shares ISA is that you give yourself the potential for higher, inflation-beating returns if your investments do well. In a nutshell, it’s a decision about whether you’re happy to take a little bit of risk in pursuit of higher potential returns. The other main difference with investing is that you’ll probably pay a fee, whether it’s a platform fee, management fee or a fund charge. Investment ISAs tend to be appropriate if your timescales are at least 3-5 years and you’re not likely to need to access your money in the meantime, although you can usually withdraw funds if you need to, sometimes for a small additional charge.
There are various ways to set up an Investment ISA, but the main ones are to pick your own investments, buy a tracker fund, or get someone to manage your investments for you. The DIY option can be cost-effective, but the charges can add up quickly if you chop and change regularly, and you need to watch out for extra costs like withdrawal fees. You should also know something about what you’re buying, so be prepared to do your homework. A tracker fund is like a multipack of investments, put together by an investing professional so it tends to be a bit cheaper and more convenient than buying them individually, and you get the added benefit of a fund manager’s investing experience. Trackers are designed to follow a market like the FTSE 100, so your returns will be linked to its ups and downs. Getting someone to manage your investments might sound fanciful, but these days it can be affordable and done completely online in less than 10 minutes. You don’t even need large lump sums to invest – just £1 will get you started if you want to test the water. This could be a good approach if you lack experience and don’t have the time to manage your own investments. You’ll pay a management fee on top of the cost of the investments, but it usually covers everything, and this approach can even work out comparable in cost to the do-it-yourself option.
Cash ISAs might suit those who:
- Are happy with a fixed return
- Don’t want to take any risk
- Might need to access their money at short notice
- Don’t want to pay fees
Investment ISAs might suit those who:
- Are happy to take a little risk in pursuit of higher potential returns
- Have a long-term savings goal in mind
- Don’t expect to need their money in the near-term
- Happy to pay a fee to invest
The tax treatment depends on your individual circumstances and maybe subject to change in the future.
Please remember that the value of your investments can go down as well as up and you can get back less than invested
*Individual Savings Account (ISA) Statistics, August 2017. Source: ONS