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ISAs - How they can help in wealth creation

March 26th 2021 – Written by Jonathan Chorley

ISAs – How they can help in wealth creation.

The much-loved Individual Savings Account or ISA was introduced to UK residents in April 1999 and they have since become a crucial component in tax efficient savings for retail savers and investors.

The most important feature of an ISA is that savings within an ISA can grow without suffering taxation on interest, investment income or capital gains.

The maximum contribution to an ISA in the current tax year is £20,000 and the ISA wrappers may be separated into Cash ISAs, Stocks & Shares ISAs and more recently Innovative Finance ISAs (introduced 2016) and the Lifetime ISA (introduced 2017).

The popularity of Cash ISAs has often exceeded that of its Stocks & Shares ISA counterpart, typically due to their security, their simplicity and until the last decade (or more) the ability to receive a reasonable rate of interest above the rate of inflation.

However, as we continue to the live in a world where interest rates are at historical lows and Central Bank policy is designed to stimulate inflation, the risk that inflation will erode the purchasing power of Cash Savings over the longer term is very real.

The chart to the right demonstrates the increase in value of a £10,000 investment in Cash (UK Savings), Equities (FTSE 100 TR) and a Mixed Investment Strategy (IA Mixed Investment 20-60%) from April 1999, with inflation included for reference –

The security of the Cash ISA would have meant that a Cash ISA only Investor would have avoided the investment declines of the Tech Bubble, the Financial Crisis and the COVID-19 volatility of last year. However, with the ultra-low interest rate policy of Central Banks in place since the Financial Crisis, the monetary return is only £12,390. 

The Investor who followed a ‘Mixed Investment’ strategy with between 20% - 60% in equities and the remainder in other assets such as Bonds, Real Estate or Alternative Assets would have achieved a monetary return of £24,172. Whilst this Investor may have had a few sleepless nights through the market crises mentioned above, the benefits of a Mixed or ‘Balanced Portfolio’ may have gone some way to offset the heady declines of an Equity only approach over the same period.

Importantly, both the Equity only and Mixed Investment strategies have exceeded Inflation over this period and protected the purchasing power of the original investment relative to increases in the Retail Price Index (RPI).

The suitability of either Cash ISA or Stocks & Shares ISA will depend on an individual’s circumstances and should you wish to discuss this in more detail please feel free to contact us.

EST. 1999