Sometimes we face uncertainties, be it our health, redundancies or unexpected household expenses. To help prepare, putting a little money aside every month for emergencies is a smart move. Experts recommend to have three months’ of living costs saved up for unforeseen moments. If you are one of the 55%[1] of men or 43%1 of women in the UK who make regular monthly savings, you may be wondering where the best place for your savings is.
What is a Cash ISA?
ISA stands for Individual Savings Account, and a Cash ISA is where you store your money as cash (rather than as an asset, such as a share). You can get one from most banks on the high street, or look online. A Cash ISA is quite similar to a normal savings account which you may already have with your bank or building society. However, there is one major difference, with a Cash ISA you have tax relief on the income you earn from interest, for up to £20,000 every year.
It is a little gift from the government designed to benefit the majority of UK earners. Children can also take advantage from Cash ISAs, known as Junior Cash ISAs they have the same tax breaks on interest for up to £4,368 (subject to change).
What are the different types of Cash ISA?
There are two main types of Cash ISA: Fixed Rate and Easy Access. With a Fixed Rate option, you would normally have a better interest rate, but you could face charges if you try to take your money out early. With an Easy Access option you can take your money out whenever you like, but the interest may not be so attractive.
ISA Savings and Investments: How many ISAs can I have?
So, you’ve saved up enough emergency funds to last you three months, what are your options now? Some great news is that you can have one of each ISA type, which you can pay into within the same tax year, and will get the tax relief for up to £20,000 in the combined accounts. So for example, this year you could add £5,000 to a Cash ISA and £15,000 to a Stocks and Shares ISA. Next year you could invest £2,000 into your Cash ISA and £18,000 into a Stocks and Shares ISA. This would all qualify for tax relief. This opens up some new possibilities for you. If you are happy with your emergency savings and ready to look into investing your future savings, a Stocks and Shares ISA could be a great place to start.
When might investing be a better option than saving?
Everyone has different financial circumstances and goals, and so there are a few different types of ISA available to match these different needs. After you have saved some emergency money, you may be looking to keep some for the long-term. In fact, you may even be looking to grow your money.
A Stocks and Shares ISA can protect your money from inflation
Preserving or growing your money in a cash savings accounts is not really possible over the long-term, unless the interest you get is higher than inflation. Inflation is when the cost of goods or services increase over time. You may have noticed that as you get older, the same products, such as Mars Bars or Freddos, have steadily increased their prices. It’s the same item, but it costs more. In an ideal world, people’s salaries would also be increasing at the same rate, but this is rarely the case. Inflation slowly eats into your savings so that you are not able to buy as many things with the same amount of money. How much you can buy is known as your “purchasing power”. After all, generally the purpose of money is to be able to buy things. If you want to preserve your wealth, you will need to try to find a way for it to outpace the rate of inflation. For example, you could look for the highest interest rate across savings accounts, but the best rates may come with hefty terms and conditions about locking in your cash.
Probably a good way to protect from the effects of inflation would be by investing in companies, such as with shares. For example, over in the U.S., the average rate of inflation since the government first began tracking it in 1913 is around 3%. However the annual returns of the S&P 500 index (shares of the largest 100 U.S. companies) since 1928 have averaged at 11.25%[2]. Investing in a mix of companies could be a good way to combat the unpleasant effects of inflation on your wealth.
Over here in the UK, the story is even more startling. Since plans of Brexit were announced in June 2016, the value of the pound has experienced some bumps, and lost around 20% of its value[3]. This has resulted in an increase of inflation during this period, which is projected to rise when there is a greater risk of a no-deal Brexit4. Protecting your wealth from inflation has become harder to do. There is no guaranteed method to beat inflation with investing, but buying stocks and shares could be good place to start . This is because when you buy stocks and shares, you no longer own cash. You own a proportion (or share) of a company. A proportion of a company will not necessarily be hit by inflation in the same way that cash or debt will be.
Inflation is a real threat to your wealth, even within investments. For example, if you made an (after tax) return of 8%, but the rate of inflation was 4% you would have only gained 4%. Considering stocks and shares in your investment plan could be a good strategy to help preserve more of your wealth.
A Stocks and Shares ISA could help increase your money in the long-term
If you want to grow your money and you are willing to leave it for more than 5 years, investing could help. Investing could potentially give you higher returns than an interest rate on a savings account.
This is because of 3 major reasons:
- By spotting a good opportunity, you can buy low and sell high. This is referred to as your “Capital Gain” and you don’t need to pay tax on this with a Stocks and Shares ISA. This means that you get to keep more of your money.
- You can earn money from your investments while you hold them, such as dividends or coupons. Dividends are your split of a company’s profit, which are usually paid out every 3 months. Coupons are the regular interest payments you could receive if you are the owner of a bond. These profits add up over time and bring extra income.
- If you reinvest your profits, you will have more money in your investment pot. The bigger pot means that the potential profits also will be bigger, which are then reinvested again. This creates a snowball effect of profits, which is extraordinary to witness over many years. You could be on the receiving end of long-term spiralling returns by investing in a Stocks and Shares ISA.
Ready to make the jump from saving to investing?
Setting up an online Stocks and Shares ISA couldn’t be simpler, with Wealthify it takes around 10 minutes. After a few questions about your financial goals and how much risk you feel comfortable taking, you can become an investor with all the perks and none of the hassle.
If you want to use your money to do your bit for the planet, you also have the option of investing in an Ethical Stocks and Shares ISA. You have the same tax relief benefits as a Stocks and Shares ISA, while doing more to preserve, protect and fund our environment, and society.
The tax treatment depends on your individual circumstances and maybe subject to change in the future. The tax rules mentioned here are accurate for the tax year 2019/ 2020.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
[1] https://www.finder.com/uk/saving-statistics
[2] https://www.wisebread.com/4-foolproof-ways-to-protect-your-money-from-inflation
[3] https://www.theguardian.com/business/2019/sep/03/pound-falls-lowest-level-three-years-brexit-election-sterling
