Isa savers should consider stocks and sharesTax-free gain may counter low rates and inflation

26 February 2011

Cash Isas accounted for three quarters of those opened in 2009-10, but with low interest rates savers struggle to beat inflation. Stocks and shares Isas may offer higher returns, but carry more risk. New investors need to consider their options.

Cash Isas

Figures from HMRC show that there were 12m cash Isas opened in 2009-10, and 3m stocks and shares Isas. The average amount deposited in a new cash Isa was £2,731 and the average in a stocks and shares Isa was £4,155. 

Cash Isas are tax-free savings accounts. The maximum sum you can invest in a cash Isa is £5,100 a year. The interest they pay varies, depending on whether they are instant-access Isas or fixed-rate Isas. As with ordinary savings accounts, the longer you tie you money up, the higher the rate. Some providers have significantly higher rates than others, however,so it pays to shop around and compare cash Isa rates. Top instant-access cash Isas (which allow transfers in) currently pay 2.8%, while the best 5-year fixed rate cash Isas pay 4.3%.    

Inflation threat 

The current rate of inflation (CPI) is 4%. Unless savers can match this, the purchasing power of their money will diminish over time. Although cash Isa returns are not reduced by the deduction of tax, many accounts will fail to keep up with inflation in the current climate. Those that do, restrict access for as much as five years. If inflation rises during this period they will also become uncompetitive. 

Stocks and shares Isas

Stocks and shares Isas allow individuals to buy a range of investments, like shares (equities), bonds, unit trusts, investment trusts and ETFs, without incurring any tax liability on the gains they make when they come to sell. You can invest up to £10,200 each year (your total Isa allowance) in a stocks and shares Isa, or put half into a cash Isa and the remaining £5,100 into stocks and shares.

The gains to be made are not limited in the same way as interest paid on savings, but they're not predictable and not guaranteed. An Isa 'wrapper' gives the advantage of avoiding tax, but within it, investments still carry risk. This varies, depending on the asset class you hold. 

Stock market gains

Following the credit crunch of 2007-8, there was a flight from equities into cash. The FTSE 100 share index fell from 6400 in January 2008 to 3512 in March 2009 and investors looked right to be wary. Since then, share prices have recovered and the FTSE 100 currently stands at 6037. Many investors on the stock exchange have enjoyed substantial gains. It's important, though, to spread risk in with your investments by diversifying into other assets.     

Novice investors

The current climate has tempted many savers to consider moving into stocks and shares. Isas are a good way of doing this, if you have not used up your annual allowance. It's important to be aware of the increased risk involved however, and that the investment does badly you could end up losing money rather than pocketing a gain. Read our beginner's guide to investment to find out how to get started as an investor. 

Which? investment expert Gareth Shaw says: 'A Stocks & Shares Isa is a great way to start your investment journey. But investing your money introduces the risk of loss, so you should only do so if you're comfortable with this.'

'If you're just starting out, ensure the cash part of your Isa is used up to it's fullest before investing. That way, you at least have some money put behind if your investments drop in value.' 

pound coins

Which? Money when you need it

You can follow @WhichMoney on Twitter to keep up-to-date with our Best Rates and Recommended Provider product and service reviews.

Sign up for the latest money news, best rates and recommended providers in your newsletter every Friday.

Or for money-saving tips, and news of how what's going on in the world of finance affects you, join Melanie Dowding and James Daley for the Which? Money weekly money podcast

For daily consumer news, subscribe to the Which? news RSS feed here. And to find out how we work for you on money issues, visit our personal finance campaigns pages.