Cash ISA vs stocks and shares ISA

Spoiler alert - it doesn’t need to be a competition.
Cash ISA vs stocks and shares ISA
Updated
April 5, 2022

Table of contents

I’m all for a good ol’ fashioned showdown. But when it comes to the cash ISA vs stocks and shares ISA duel, it shouldn’t be a fight.

It’s not an either-or situation.

You can hold a cash ISA and a stocks and shares ISA at the same time, and they don’t even have to be with the same provider. 

But even though you can have both doesn’t necessarily mean you should. Depending on your individual circumstances and financial goals, one of the two ISAs might make more sense for you. It also could be the case that each ISA serves its own purpose and helps you work towards a number of different financial goals. 


What is a stocks and shares ISA?

A stocks and shares ISA is sometimes called an investment ISA. That’s because you use this ISA to make investments in a tax-efficient way. 

In a stocks and shares ISA, you won’t pay income tax on dividends or interest. You also won’t pay capital gains tax if you sell your investments for a profit.

As an investor, you’ve got a smörgåsbord of options for what to put inside your stocks and shares ISA. You could start with some exchange-traded funds (ETFs), add in investment trusts, sprinkle in some stocks and even fold in real estate investment trusts (REITs) if you’d like. The investments you choose for your stocks and shares ISA are entirely up to you. 

It’s important not to put all your eggs in one basket when you choose what to invest in. Diversifying your investments will help you spread risk across multiple assets as opposed to relying on one, often a sensible strategy to hit your personal financial objectives.


Can you hold cash in a stocks and shares ISA?

You can still hold cash in a stocks and shares ISA too. Though, that’s not the best home for it.

Here’s a great article by Freetrade’s Paul Allison on why cash can be a drag on your portfolio’s performance.

If you have cash in a stocks and shares ISA, it’s probably sitting there waiting for a ride to its final destination. After all, a stocks and shares ISA is for making tax-efficient investments, so you’re depositing money into that account with the intent of buying and selling shares.


Read more:


What’s a cash ISA?

A cash ISA is where you might consider depositing your savings if you don’t want to invest them. But the return on a cash ISA isn’t great, and it’s particularly low in the context of rising UK inflation.

That said, if you have a short time horizon (or you’re not yet sure of what that horizon even is) with a main goal of preserving your capital, they could be right for you.

But if you want that money to grow, then a stocks and shares ISA is probably more up your street.

The main benefit of a cash ISA is that your savings will earn interest without having to pay tax. This is the main way it differs from a traditional savings account.

But many wouldn’t actually pay tax on interest from a regular savings account to begin with, because of their Personal Savings Allowance (PSA).

And with the Bank of England (BoE) reporting interest rates at “new historically low levels” you would need to save a lot to earn enough interest to exceed the £1,000 limit for a basic taxpayer. 

For instance, if you were earning 1% interest on your savings account, you would need to have £100,000 deposited to earn £1,000 in savings interest.

 

The difference between a stocks and shares ISA and a cash ISA

Now that you’ve got a sense of how the two accounts differ, you may be humming and hawing over which to choose. Technically, you can actually have both a cash ISA and a stocks and shares ISA at the same time. You can even pay into both ISA accounts in the same tax year. 

But each ISA serves a different purpose, and because your tax year contribution allowance is split across all of your ISAs, it’s wise to prioritise a certain account according to your financial objectives.

The 2022/2023 tax year starts on 6 April 2022 and ends on 5 April 2023. This tax year has a £20,000 contribution limit.

If you have a short term horizon and aren’t interested in growing your cash at a rate that covers or goes above inflation, then a cash ISA might be right for you. But if you want your cash to grow in purchasing power and have a longer-term horizon for your financial goals, a stocks and shares ISA would be better suited for you.


Should I save my cash or invest it?

Putting your cash in a cash ISA may seem like a safe way to protect your money. Though if you’re looking to grow your savings and beat inflation, cash is unlikely to be the answer. 

When you invest in stocks and shares, you’re putting your money to work. This is why your long-term return with a stocks and shares ISA could be higher than with a cash ISA. 

So let’s say you want to save some money but you plan to take it out in the next few months. In that case, it could make sense to keep the cash in a general savings account rather than a cash ISA, where your contributions would eat away at your total allowance. Its value is also unlikely to fluctuate in the same way any invested money in a stocks and shares ISA could. 

The trade-off is normally that you have to accept a lower rate of interest on your savings in exchange for that low level of risk on cash, when compared to the S&P 500 for example.

What are returns like for a cash ISA?

If you invested in a cash ISA between December 2020 to 2021, your average total interest rate for the year would have been 0.34% [1].

Meanwhile, The Consumer Prices Index including owner occupiers’ housing costs (CPIH) rose by 4.8% in the 12 months to December 2021. So your cash in a cash ISA would have eroded in value, and would be worth less than it was at the start of the year.

The value of your money would likely be greater had you invested it. For instance, if you had invested in the S&P 500 for the 12 months to December 2021 your average return was 26.7%.

2021 was an exceptionally high performing year for the US stock market, and the value of your investments can always go down as well as up. It’s important to note that you can get back less than you invested when you buy stocks and shares too. The point here is that the average interest rate in a cash ISA has never come close to such a high return. 

Accessing cash from a stocks and shares ISA has an extra step, as you’ll have to sell an asset and withdraw it. That’s actually a straightforward transaction but the issue is that your investments might be going through a down period. Withdrawing at that point would lock in a loss. This is why investing is better the more time you give it - over time, steady long-term investments can iron out any short-term kinks. 

 

Past performance is not a reliable indicator of future returns.

Discrete calendar year performance
Investment 2017-18 2018-19 2019-20 2020-21 2021-22
S&P 500 6.2% 9.5% 25.0% 11.5% 18.2%


FE, as at 7 Feb 2022. Basis: bid-bid in local currency terms with income reinvested.

Are stocks and shares ISAs risky?

While your return is likely to be greater with a stocks and shares ISA over the long term, that also means the level of risk is greater too. 

That’s because you’re investing in the stock market, which means your return could go down or up. There’s a risk that you lose all of the capital that you invest. This would be much less likely in the case of a cash ISA. 

If your ISA provider went under, your ISA would be covered by the Financial Services Compensation Scheme (FSCS) up to a maximum value of £85,000. This is the case for both cash ISAs and stocks and shares ISAs too.

 

How to transfer a cash ISA to stocks and shares ISA?

The most important consideration when opening a stocks and shares ISA is whether it’s the right decision for you. There are a number of factors to consider when assessing this, including your own financial goals, time horizon and tolerance for risk. 

If you then decide you’d like to take the cash out of your cash ISA and invest it in your stocks and shares ISA instead, then it’s entirely possible and relatively easy to do. 

That’s good news, because when you transfer money between your ISAs, you won’t lose your allowance. But if you close one ISA and open another in a given tax year, your allowance won’t reset. So whatever you may have deposited earlier on in the year cannot be re-added to your new ISA.

For more information on the ins and outs of the process, we’ve got you covered with our article all about ISA transfers.


Can I pay into a cash ISA and a stocks and shares ISA in the same year?

You sure can.

As long as you’re paying into different ISA types, you can pay into multiple accounts in the same tax year. And paying cash into both ISA accounts could be a good way to prepare for your short-term and long-term financial needs. 

You could open a new ISA with a different provider every year if you wanted. You also don’t need to use the same provider for your cash ISA as you do for your stocks and shares ISA. 

You can shop around if you’d like as well, you’re not married to any particular type of ISA nor to any particular provider.

If you do pay into a cash ISA and stocks and shares ISA in the same year, bear in mind your £20,000 allowance covers your contributions across both. So double-check that you’re not going over the limit. 


Cash ISA or stocks and shares ISA?

To bring it right back around to where we started, cash ISAs and stocks and shares ISAs both have their place.

You could keep the money that you want to save and access in the short term in a cash ISA. But if you’re ready to take some investment risk and want to grow that money (and hopefully combat the effects of inflation) in a tax-efficient way, then a stocks and shares ISA might be better suited for your needs.

That’s because, unless the interest rate you receive on your cash ISA is higher than the rate of inflation, your money will be worth less in the future.


How will inflation impact my savings?

Let your mind wander to the chocolate aisle of your local Sainsbury’s for a moment. Picture a freshly-stocked shelf filled with Mars bars staring you in the eye.

In 1980, one bar would have cost you 15p. Today, the chocolatey goodness would run you 50p on average.

Inflation, or the rising cost of goods, is constantly eroding the value of what we can actually buy in the real world. All these years later you might still physically have the 15p in your hand but that Mars bar is now out of reach. Nightmare.

Alternatively, if it was 1980 and instead of buying the Mars bar you decided to take the 15p and deposit it in a savings account, you would need an average annual interest rate of around 2.9% to be able to afford that same Mars bar in 2022. 

The Council of the Buildings Societies Association (BSA) reported the average interest rate for savings accounts was 10.3% in 1980. Last year, the average interest rate for a one-year fixed rate ISA was 0.5% as interest rates neared record lows. 

So these savings rates have fluctuated heavily over the years, and can’t necessarily be counted on to rise with inflation.

Interest rates have been very low since the global financial crisis in 2008 and, while the signs are there that they are rising in the US and UK, they aren’t covering inflation right now.


How can I open an ISA?

If you do decide to open an ISA, remember that the deadline is midnight on the 5th April 2022 for cash ISAs and stocks and shares ISAs. If you don’t open your ISA by then, you won’t be able to take advantage of this year’s £20,000 ISA allowance. 

This is important to keep in mind because you can’t carry forward any unused ISA allowances. If you don’t use it, you’ll lose it.

If you do open an investment ISA, your investments can go down as well as up in value. If you’re comfortable with this risk and happy to choose your own investments, then a stocks and shares ISA might be right for you.

Our step-by-step guide on how to open a stocks and shares ISA is ready to walk you through the process if so. 

[1] Bank of England Database, https://www.bankofengland.co.uk/boeapps/database/fromshowcolumns.asp?Travel=NIxAZxSUx&FromSeries=1&ToSeries=50&DAT=RNG&FD=1&FM=Jan&FY=2021&TD=31&TM=Dec&TY=2025&FNY=Y&CSVF=TT&html.x=66&html.y=26&SeriesCodes=LPMB6F2&UsingCodes=Y&Filter=N&title=LPMB6F2&VPD=Y

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Important information on SIPPs

SIPPs are a pension product designed for people who want to make their own investment decisions. You can normally only access the money from age 55 (set to rise to 57 from 6 April 2028).

This article is based on current rules, which can change, and tax relief depends on your personal circumstances. When you invest, your capital is at risk.

The value of your portfolio can go down as well as up and you may get back less than you invest.

Before transferring a pension you should ensure you will not lose valuable guarantees or incur excessive transfer penalties. Pensions are usually transferred as cash so you will be out of the market for a period.

Freetrade does not currently offer drawdown products for our SIPP.

Important information

This should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice.

When you invest, your capital is at risk. The value of your portfolio, and any income you receive, can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future results.

Eligibility to invest into an ISA and the value of tax savings both depend on personal circumstances and all tax rules may change.

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