Cash ISAs Vs. Investment ISAs

If you’re trying to decide whether to put your money into a cash ISA or an investment ISA, this is a good place to start. Which option is  optimum for your circumstances depends on a range of factors, from your long-term financial goals, to your appetite for risk.

In this article we explore the major differences between these products, how to compare them, and where to get expert investment advice.

What’s the difference between a cash ISA and an investment ISA?

While they sound similar, and share the same £20,000 annual personal tax-free savings allowance, these are actually two very different types of financial product.

Cash ISA

This is similar to a typical savings account, with the exception that interest earned is tax-free (up to £20,000). With a regular savings allowance, you’ll pay tax on any balance held above your independent tax-free allowance, which is much lower, or zero if you're a higher-rate taxpayer. They provide low risk and fairly predictable returns.

Investment ISA

A higher risk option, with the potential for much higher returns. Also referred to as a ‘stocks and shares ISA’ they provide a tax-efficient environment for a variety of your investment assets, including:

• Individual stocks and shares

• Corporate and/or government bonds

• Exchange-traded funds (ETFs)

While an investment ISA is a non-interest earning account, the potential returns from tax-free capital growth and/or dividend income can be substantially more than you would earn from the interest on an equivalent cash ISA.

As this is an investment product, you can also lose money, however. Be sure to take professional advice if you’re new to investing.

Key features of both products compared

How to compare ISA deals

One of the main considerations when it comes to comparing these two products is your personal appetite for risk. However, it’s always best to seek out expert independent investment advice before you make any major investment decisions.

Here are some of the key factors they will help you assess:

Comparing cash ISAs

• Whether there’s a fixed interest rate period

• Whether there’s a withdrawal penalty or loss of interest if you withdraw early

• How the Annual Equivalent Rate (AER) compares to similar products

• Whether the initial interest rate include a bonus that drops off after 12 months

• If the ISA flexible (you can withdraw cash and replace it within the same tax year without eating into your remaining tax-free allowance)

Comparing investment ISAs

• Whether the account has ready-made portfolios or allows you to pick your own shares

• The fund’s performance over the past 3, 5, and 10-years

• How much the platform management charges are compared with other options and whether they are charged as a fixed monthly charge or a percentage of your portfolio

• Whether there are additional fund management fees

• What the trading fees are when you buy or sell shares

Why choose a cash ISA?

If you’re looking for a low risk investment, have shorter-term savings goals, and/or want your funds to remain accessible, a cash ISA may be the best option for you. There is very little volatility, other than fluctuations in your savings interest rate. While a fall in interest rates could mean you won't earn much interest, your capital is not at risk in a cash ISA. 

However, keep in mind that this is not the best option for those looking for significant growth from their investment. It’s also worth noting that if inflation rises faster than your ISA’s interest rate, the real world value of your funds will reduce.

Why choose a stocks and shares ISA?

An investment ISA is ideal for those looking to build wealth. If you have a slightly higher appetite for risk and are happy to hold out for longer term returns, investment ISAs typically substantially outperform equivalent funds held in a cash ISA account.

They also give you the opportunity to take advantage of a much more diverse investment strategy. Rather than relying on the fate of a single interest rate, you can build a portfolio of various types of global stocks and bonds, giving your funds far greater potential to perform.

However, alongside opportunity, it’s important to understand the level of risk involved in this type of investment. The value of your portfolio will fluctuate daily based on market conditions. Particularly if you are looking to withdraw funds in the short term, there is a possibility you could get back less than you invested.

Alternatives to ISAs

Whichever type of ISA is right for you, they each provide you with an annual tax-free savings allowance of £20,000. However, if you’re looking for an investment vehicle that is more tailored to a specific life event, such as retirement, a SIPP (Self-Invested Personal Pension) may be more suitable. Likewise, if you’re under 40 and saving for your first home, a LISA (Lifetime ISA) is likely to be the most effective option.

If you’ve hit your £20,000 ISA limit and would like to invest further, you could also consider the following options:

• Personal Savings Accounts - Basic-rate taxpayers can earn up to £1,000 and higher-rate taxpayers £500 in interest-free savings on top of the personal ISA allowance. If you are a higher-rate taxpayer, however, you do not benefit from this additional allowance

• General Investment Accounts (GIAs) - Unlimited investments are possible, but these will be liable for both capital gains and dividends tax. As the tax-free thresholds for both of these has recently dropped significantly, however, it’s unlikely that this would be more tax efficient than an investment ISA, so it’s best to seek advice before prioritising this type of account

• National Savings and Investments (Premium Bonds) - These investments don’t guarantee returns, but equally your capital is not at risk. You are entered into a monthly prize draw for up to £1million, gaining an entry for every pound held (maximum £50k)

• Junior ISA (JISA) - If you’re saving money for your children, you get an addition £9,000 annual allowance for each child under the age of 18

Speak to an independent financial adviser

Deciding between a cash ISA, an investment ISA, or whether a combination of both may be right for you, can be challenging. However, speaking to an independent financial adviser (IFA), especially where your funds could be at risk, can be highly beneficial.

At Money Helpdesk, our specialist IFAs can help you to build a bespoke financial strategy and investment portfolio, tailored to your personal goals and risk tolerance. They will also ensure your chosen portfolio is as tax-efficient as possible.

For a free initial consultation with no obligation to proceed, get in touch to speak with an independent investment ISA expert