Save, make, understand money


BLOG: Rising inflation is one more reason to choose a stocks and shares ISA

Paloma Kubiak
Written By:
Paloma Kubiak

What differentiates an ISA from other types of accounts is the fact you don’t have to pay tax on the returns you make. What happens in an ISA, stays in an ISA.

It’s a tax benefit that gets better and better the more you save. This is why we struggle to understand why most ISAs in the UK are held in cash since savings rates are at pitiful levels.

According to the latest government figures, cash ISAs account for £270bn of Britain’s savings, with £44bn added to them last year alone.

You might be getting a tax saving on your interest but with rates as low as they are, this saving is likely to be virtually negligible. Making matters worse, the value of your money is being eroded by inflation.

As inflation chips away at the value of the pound in your pocket, it also chips away at the purchasing power of your savings. The only way to overcome that is if your capital growth outpaces inflation with a higher return than you’re able to get on your cash savings.

We believe the best chance of inflation-beating success is to take some risk with your money while also managing those risks with an appropriate investment strategy. That is where a stocks and shares ISA rather than a cash ISA can help.

Cash does have a key role to play in the finances of every household. Having enough cash to cover at least three months of outgoings is sensible contingency planning, so if you don’t have this, wait until you do before you start investing.

Inflation impact

To illustrate how even low levels of inflation can erode your savings, here are some quick calculations. Just 2% price inflation per year for the next 35 years would, in total, result in a 100% increase in prices over that period. In other words, £1,000 of today’s money would buy just £500-worth of goods and services.

Indeed, the Bank of England’s inflation calculator shows it took just 25 years for this to happen in the period up to 2021, when annual inflation averaged 2.8%.

So, imagine the extra negative impact now that inflation has risen higher. This all leaves you, as a saver, with reason to ponder whether investing in a cash ISA is worth it at all.

Time to re-evaluate?

While you might be getting a tax saving on your interest, with rates as low as they are, this saving is likely to be virtually negligible. Making matters worse, as we have shown, the value of your money is being eroded by inflation over time.

With a stocks and shares ISA you’re taking on more risk – because markets can go down as well as up. But you are potentially getting a better return too. A hypothetical annual return of 5%, for example, would have enabled £10,000 to have grown to a nominal £30,000 over the same period (that’s before inflation).

What’s more, actual long-term stock market returns in real (inflation-adjusted) terms have consistently been positive for a very long time.

So, if you’re already covered for emergency cash funds, maybe it is time to consider a stocks and shares ISA for your future savings instead of (or in addition to) your cash ISA.

Under current rules, every adult in the UK can save up to £20,000 per year in an ISA and they can split that allowance across different types of ISAs too. So, you could easily have a stocks and shares ISA and a cash ISA.

You can also transfer money between different types of ISA. If you’ve already built up some savings in a cash ISA, there would be nothing to stop you moving part or all of that money into a stocks and shares ISA.

Just remember not to initiate a transfer too close to the tax year-end on 5 April if you haven’t yet taken up your full 2021/22 ISA allowance and intend to pay more into your ISA before then. Just to be on the safe side, we suggest you pay in any remaining money prior to initiating your transfer.

When choosing your stocks and shares ISA provider, remember also to look at how much they charge for the privilege of investing your money and the range of low-cost funds that they offer.

Costs can erode savings just as inflation can, so always look out for things like annual platform fees, transaction costs and costs of the funds you invest in. The lower the costs, the greater your chances of investment success.

James Norton is head of financial planners at Vanguard, Europe