A new tax year means a clean slate for the tiny tax haven that is the individual savings account – or ‘ISA’ for short.
As of 6 April, the UK’s savers and investors can again shelter up to £20,000 each from tax on interest, income and capital gains generated by whatever assets they choose to hold in their ISA and again – at least to us, here on The Value Perspective – the great majority are failing to make the most of the opportunity.
By the end of the 2017/18 tax year (the most recent for which official figures are available), around 10.8 million people had subscribed to an ISA of some description.
While some picked the comparatively new options of the Lifetime ISA (166,000) or Innovative Finance ISA (31,000), the great majority went for the more established Cash or Stocks & Shares varieties – and we will come to specific numbers in a moment.
Now, clearly, the larger your gains from the assets held within your ISA, the bigger the tax break you enjoy, which begs the question as to how you can look to increase your gains.
Obviously you can invest as much as you are allowed – the aforementioned £20,000 per adult in the current tax year – but, after that, it comes down to what you invest in and for how long.
In other words, you give yourself the best chance of boosting your gains and thus the associated tax breaks by investing in potentially higher-returning assets and over a longer timeframe.
And while those may look like two choices, they both stem from considering the same question – for how long do you want to invest?
For not only will your answer directly address the timeframe issue, it will also dictate what sort of asset you buy.
Why does time matter?
The prices of most investments – shares, bonds, property and so forth – rarely stay still for long.
Sometimes the prices will go up, sometimes down and this volatility, as it is known, tends to be more pronounced over shorter time periods.
The longer you invest for, however, the less worried you need to be about volatility because, over longer time periods – 20 years, say – investments tend to move back to a long-term average (although not guaranteed).
Data going back to 1964, for example, shows the average real return on stocks – that is, once the erosive effects of inflation are taken into consideration – is about 7% a year while the equivalent for cash is roughly 2% a year (past performance is not a guide to future performance and may not be repeated).
That being so, then, why does the HM Revenue & Customs data for the 2017/18 tax year reveal roughly three times as many people subscribed to Cash ISAs as to Stocks & Shares ones?
Cash ISA over Stocks & Shares?
That 72% of all ISAs taken out in that tax year were of the cash variety is a remarkable enough statistic on its own but it becomes even more so when you consider the poor returns available on cash these days.
According to MoneySavingExpert.com, for example, only a handful of fixed ISAs and not one easy-access ISA can match the current 2.1% rate of inflation.
That provokes another important question: just how many people will actually need the tax break on offer for any gains made – which was presumably a big factor in their opening a cash ISA?
Clearly there will be plenty of people who, while understanding the attractions of an ISA, may be put off by the volatility associated with a stocks and shares one.
Long-term stockmarket returns are, as we said, very attractive but, over the last decade, they have proved lower than average while price volatility has been unusually high.
On the other hand, as we also said, the longer you are prepared to hold your investment, the less of an issue this becomes.
Still, for anyone who might want access to their investments over the next couple of years, this presents a significant risk – after all, nobody wants to be in a position where they are converting an equity investment back into cash just as stockmarkets are having a bad time.
What about Junior ISAs?
There is one group of ISA investors, however, for whom this is simply not an issue – and that is anyone who invests in a Junior ISA, which is currently the government’s way of encouraging people to save on behalf of children.
Any fortunate beneficiary of a Junior ISA is unable to redeem their investments until they reach 18 or, in the case of the cash version, 16.
By definition, a significant percentage of money flowing into Junior ISAs has to adopt the sort of long-term time horizon that suits stockmarket investment so well.
And yet, according to HM Revenue & Customs, almost three-fifths (57%) of the £902m subscribed to Junior ISAs in 2017/18 was in cash.
That is a slightly lower percentage than the previous year (61% of £858m) but, even so, such a skew makes absolutely no sense whatsoever as a long-term investment of 18 years would clearly be more suited to stockmarket investment.
Granted, the investment would be at risk and yet, over such a lengthy period, there would be time for any losses or be regained and any volatility to be smoothed out.
For how long you are willing to tie up your money is one of the most fundamental questions for any investor to address.
Patterns of behaviour in the ISA market suggest, however, that players at every level – government and fund managers, advisers and investment platforms – need to work harder at engaging consumers and encouraging them to think hard about what they want to achieve from their ISA.
In an uncertain world, it is all too easy to become paralysed by fear and let short-term risk considerations unduly affect long-term investment choices.
The impact of this sort of thinking on the long-term financial security of UK consumers is, however, potentially disastrous.