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Cash or investment ISA? Know the differences

Cash or investment ISA? Know the differences

Category: ISAs

Updated: 07/05/2014
First Published: 07/05/2014

MONEYFACTS ARCHIVE
This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

If you're looking for a savings account to squirrel away your hard-earned cash, chances are ISAs have sprung to mind. And with good reason – these tax-efficient accounts let you rack up interest without needing to give the taxman a share, and with the tax-free allowance set to rise to £15,000 in July they'll soon be even more beneficial.

But, have you considered an investment ISA instead? Probably not, and in fact research from Scottish Friendly has found that 48% of respondents don't actually know the difference between a cash and investment ISA, despite the fact that 38% view saving into an ISA a necessity – and save on average over £100 per month.

This lack of understanding could potentially cost savers as much as £1,278 each year, according to calculations from the mutual, and there are concerns that when the new rules come into force the majority of savers will put their allowance into lower rate cash ISAs rather than exploring investment ISAs for the potential of better returns.

So, isn't it time you understood the difference? Let's take a look at them both in turn.

CASH ISA

Cash ISAs are exactly what they say on the tin – they're accounts that let you save in cash, keeping things simple and giving you a great home for your money.

There are various different versions you can choose from depending on your circumstances, such as instant access accounts (where you can put money in and take it out as often as you wish) and fixed rate versions (where you'll deposit a lump sum and keep it in for a fixed length of time, with the trade-off usually being a better rate than with instant access accounts), and any interest will be entirely free from tax.

And, because you're saving in cash there's no risk whatsoever – as long as you don't deposit more than £85,000 with any one institution you'll be covered by the Financial Services Compensation Scheme (FSCS) should the bank get into financial difficulties, and although savings rates aren't exceptional you'll never get back less than you put in.

INVESTMENT ISA

An investment ISA, otherwise known as a stocks and shares ISA, is a bit different. In this instance you're not saving in cash but are instead actively investing your money in the stock market, but you still retain the tax-efficient element of a traditional ISA.

Again there are different types you can choose from, this time depending on whether you want to invest in individual shares yourself or leave it to the hands of a fund manager, but the majority of these accounts will use collective investment funds to spread risk and allow you to invest across a range of different areas.

However, the most important thing to bear in mind is that your money isn't necessarily safe. There's a greater amount of risk quite simply because you're actively investing in the stock market – you're not getting a set interest rate, so your returns will depend entirely on the performance of the funds and there's a chance you'll be left with less than you put in.

It's more suited for those with a longer-term view of investing as well, as although you'll usually be able to access your money should you need it won't be as easy as with an instant access cash version. It's also important to remember that although the FSCS still applies, the rules for investors are slightly different and you'll only be covered for up to £50,000.

Having said that, there's still the potential for better returns when compared to a traditional cash ISA – Moneyfacts figures show that the average stocks and shares ISA fund posted growth of 9.42% during the last tax year, whereas the average interest rate on cash ISAs over the same period was just 1.69%.

Which one will you pick?

Ultimately, it's entirely down to you. Cash ISAs will be more suited for those who don't want to risk any of their capital whatsoever and prefer the safe haven of a traditional savings account, while those who are comfortable with an element of risk for the potential of better returns might like to consider investment, or stocks and shares, ISAs instead.

However, a key misconception is that people tend to think of investment ISAs as only being suitable for those putting aside significant amounts of money each month, when in reality there's little deviation from the requirement of cash ISAs. Some investment versions can be found that will let savers pay in as little as £10 per month, so although the appetite for risk still needs to be there, the vast wealth doesn't.

It's your choice, and although you're currently restricted in how much you can save in cash, by 1 July you'll be able to save up to £15,000 however you please – so it could pay to consider both options.

What next?

Check out our pick of the top cash ISAs

Compare stocks and shares ISAs

Find out more about ISAs and the new ISA rules

Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.

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