"My cash ISA is paying a paltry interest rate and moving it will not make much difference. I would like to get a higher rate of return. A friend tells me it is possible to move it to a stocks & shares ISA. Can you explain the rules and any pitfalls?"
Many people are in the same boat – they're saving into cash ISAs, but even with their tax-free status, they're not producing the returns that we'd like. So it's a toss up between "grin and bear it" or trying to earn a higher rate of return by looking at investments. So, as well as the specific risks associated with investing, what exactly are the rules and pitfalls when it comes to investing in a stocks & shares ISA?
The reason that investments have the potential to earn you more than cash ISA savings is because your money is at risk. As much as an investment can increase in value, it can also decrease in value – you can lose money. So here's the first pitfall of a stocks & shares ISA over a cash ISA:
Some ISA providers will "guarantee" return of your money in a type of product called a "structured investment". Often an ISA provider will be packaging a third party provider's product, so the guarantee could be the third party's, not the actual provider who you are applying through. Make sure you check that both the provider and any third parties are covered by the Financial Services Compensation Scheme before proceeding.
Another thing to bear in mind with investments is that they're not something you should consider as a short-term undertaking. An investment is aimed at producing long-term growth, which may mean, in the short term, that if you tried to withdraw from an investment, you may come out with less money than you put in.
In the 2016-17 tax year you can invest up to £15,240 in a stocks & shares ISA. This maximum figure is based on you not having contributed into a cash ISA: you can also place up to £15,240 in a cash ISA, but that limits the amount you can put in your stocks & shares ISA.
Finally, you can only open one investment ISA and one cash ISA per tax year, although you can open a new one every year if you wish, or can transfer funds to keep your ISA pots in the same place.
So, it boils down to whether you feel the risks of investing are worth it. An investment decision should be a properly reasoned choice, looking at the pros and cons of the product – ultimately you have to be prepared to risk losing your money.
While this may be an extreme scenario, it's not beyond the scope of possibility; and although the potential for returns on a stocks & shares ISA outweigh those on a cash ISA, it will be up to you to decide.
As paltry as returns are on cash ISAs at present, your money's not at risk in the same way as it would be in an investment.
You should view using a cash ISA as a method of tax-free saving for things such as an emergency fund or for a holiday – in other words, short-term savings goals. It's also appropriate for longer-term saving if you don't wish to risk your money.
If you are unsure whether stocks & shares ISAs are suitable for you, it's important that you seek the guidance of an independent financial adviser to help you make the right choice.
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