Cinema or skydive? Librarian or rock star? Pea soup or vindaloo? Choosing between the safe and steady option or something more action-packed usually depends on your appetite for risk. It’s similar when considering whether to put your money into a Cash ISA or a Stocks & Shares ISA. But if you’re the type of person who tends to jump straight for the safe option, there are a few things you should consider first.
Cash will keep your money safe but won't work hard over the longer term
There's a lot to be said for boring and safe. You know what you're in for. And thanks to the Financial Services Compensation Scheme, up to £85,000 of your cash savings are guaranteed in most institutions.
But over the long term, you may actually be losing out. Interest rates have remained low for a long time, and this year the Bank of England cut interest rates to 0.1% in response to the coronavirus crisis. This is much lower than the current rate of inflation. So while the balance of your cash savings may stay the same, it’s likely that you’ll be able to buy less with it over the years. Some Cash ISAs or savings accounts will have a slightly higher interest rate, but it’s still likely to be fairly inconsequential and you’ll usually have to lock away your money for a set period of time.
Cash ISAs can still be useful though. Most financial advisers will suggest you try to save between three and six months' salary to cover life's unexpected emergencies. Also, if you intend to save for something you’ll need the money for within a couple of years, like a holiday or wedding, then putting your money into a Cash ISA is a no-brainer. It’s unlikely to grow much in value but there’s also no chance that you’ll lose it.
A Stocks & Shares ISA makes more sense than a Cash ISA if you’re saving for over five years
People tend to put their money into Stocks & Shares ISAs because there’s a good chance that the investments within them will do better than cash over longer time frames. After two years, the probability of equity investments (also known as stocks and shares) beating cash is 69%, but after 10 years this rises to 91%. These figures come from The Barclays Equity Gilt Study, which has analysed the performance of equities versus cash every year since 1899.
On paper, it’s hard to dispute why you might want to consider investing in equities. But you do have to mentally prepare yourself for market volatility – when the value of your investments goes up and down, sometimes fairly significantly. However, try not to pay too much attention to short-term ups and downs – your money will have an opportunity to recover from any short-term losses over the longer term. Remember though that the value of all investments can go down as well as up, and may be worth less than was paid in.
What you should try to avoid is becoming a ‘forced seller’, when you need the money tied up in your investments and are forced to sell at a time when their value has fallen. If you’re able to leave your investments alone and wait for values to rise again, you should avoid this pitfall. And this is where having cash savings for emergencies comes in – it means you can leave your investments alone.
Stocks & Shares ISAs have great tax benefits too
Currently you can invest up to £20,000 a year into a Stocks & Shares ISA and pay no tax on any increase to the value. No strings – it’s a benefit from the government.
You can open one Stocks & Shares ISA each year (as well as one Cash ISA, which shares the £20,000 tax allowance). Remember though that laws and tax rules may change, and the value of tax benefits depends upon individual circumstances.
Let’s recap the generally accepted savings and investing guidelines
- Emergency cash: try to have three to six months of cash savings in a Cash ISA or an easy-access savings account
- Short-term savings: if you need to access your money within a couple of years, keep it in a Cash ISA or find a savings account with a slightly more favourable interest rate (although bear in mind that this is usually at the expense of locking away your money for a set period of time)
- Long-term savings: invest up to £20,000 a year in a Stocks & Shares ISA – you still have the option of having access to your money, but try to avoid touching it for at least five years or when market conditions aren’t favourable
If you already have a Standard Life Stocks & Shares ISA, and want to make the most of your £20,000 yearly allowance, log in here to pay more in.
Alternatively, you can find out more about Standard Life’s Stocks & Shares ISA here. Or to open a new Stocks & Shares ISA, select the link below.Open an ISA
The information in this article should not be regarded as financial advice.
All information is based on Boring Money’s understanding in November 2020.