The interest rate you get on a cash Isa is still pretty abysmal. Your weekly food shop, energy bills, transport costs – all of it was 5.5% more expensive at the start of this year than in January 2021. Meanwhile, the Bank of England’s key interest rate is still below 1% and it’s very hard to get a savings rate that yields much more than that. You don’t have to be a maths wizard to work out that with that disparity, your wealth is being inflated away rather too rapidly for comfort.
This is where a stocks and shares Isa can help. Also known as an investment Isa, a stocks and shares Isa allows savers to invest in a broad array of assets. And here’s the important bit – all of it is sheltered from tax. You can tuck away everything from shares to bonds to property in the form of real-estate investment trusts (Reits), plus open-ended funds (Oeics) and exchange-traded funds (ETFs).
The key to building a resilient portfolio is to diversify your investments across asset classes with different attributes, so that if, for example, the value of your shares goes down, the loss will hopefully be offset by the value of another asset – gold say – rising. In other words, you want to spread your risk in order to achieve long-term growth with the least bumpy ride possible.
The magic of compounding
Although stocks and shares Isas do offer you the flexibility to get your money out whenever you want to, it’s best only to invest money you can afford to put away for five years, and preferably more. That way, the performance of your investments should be able to ride out any of the bumps in the road over the years. You can do that with cash Isas too, of course – but the point is that, whereas the value of your cash Isa will grow only slowly in nominal terms, and will quite likely lose money in “real” terms (ie after inflation) at current rates, the value of your stocks and shares Isa should rise faster and deliver a genuine real return – again, over the long term. There are no guarantees, of course. Unlike cash, the nominal value of your stocks and shares Isa can go down as well as up. But over the long term, you should rack up respectable capital gains, and there’s the income from your investments to think about too.
Many companies pay dividends out of their earnings. The equivalent for bonds is the “coupon” – the interest on the loan you make to the bond issuer. You use this income to buy more shares, and the more shares you own, the more income you’ll receive. Albert Einstein (albeit apocryphally) described this compounding effect as the “eighth wonder of the world”. You can do all of it via a stocks and shares Isa.
Will that be enough to beat inflation? Perhaps not easily right now, with consumer prices rising at such a lick. But over the long run – and we’re talking more than a century-worth of data here – the annual Barclays Equity Gilt Study suggests that British stocks have returned around 5% a year in real terms, compared to less than 1% for cash.
And, as MoneyWeek readers will already know, Britain’s benchmark index – the FTSE 100 – is home to oil giants and mining companies that have tended to do well in inflationary environments in the past. Holding gold (via an ETF), although it pays no income, adds another defensive layer against rising prices over the very long term.
Use your annual Isa allowance or lose it
In terms of what you can put away, the Isa allowances are generous. You can top up your Isa by up to £20,000 for the 2022-2023 tax year. Admittedly that allowance hasn’t increased since 2017-2018 (a particularly stealthy form of “fiscal drag”) but it should be sufficient for most people, and if not, look to some of the other tax-efficient wrappers out there.
Note that this is a “use it or lose it” situation – you cannot roll this allowance forward. If you already hold investments outside of your stocks and shares Isa, it might be worth using a neat trick called “bed and Isa”. This is where your Isa provider sells your shares and buys them back inside your Isa quickly to minimise any price movement. If selling puts you in danger of breaching your capital gains allowance of £12,300 for this year, consider spreading the sales of your investments between different tax years. You also don’t have to choose between having only a stocks and shares Isa and any other kind of Isa. You can pay into one of each kind of Isa in any one tax year as long as you don’t go over your £20,000 limit for all of your Isas. So, you could, for example, put £10,000 in a stocks and shares Isa, and another £10,000 in cash Isa. But not £20,000 in each.
You can see a list of providers here. When choosing a provider, look at the annual charges and the cost of buying and selling shares and funds, along with which investments the provider allows you to buy and sell. The annual charges will be either a flat fee, which is better for larger amounts (Isas worth over £25,000) or a percentage of the value of the Isa. Generally speaking, dealing charges will depend on how wide a selection of products are on offer and how flexible the platform is – a full-service platform will charge more per trade but have a wider range of products available.