MONEY COMMENT
You Choose: Cash, Bond Or Share ISA

By Cliff D'Arcy
March 27, 2003

Occasionally (but only occasionally), I feel sorry for the civil servants at the Treasury. As if helping the chancellor to balance the nation's finances isn't tricky enough, they have to keep a watchful eye on the retail financial services market (that's financial products aimed at you and me). It's hardly surprising that they get criticised when new products are introduced, because you can't please all of the people all of the time.

Take Individual Savings Accounts (ISAs), for example. They were launched in 1999, aimed at replacing a savings product (the TESSA) and an investment product (the PEP) which were introduced by previous Conservative governments. By introducing one product to replace two forerunners, the Treasury has been accused of constructing an overly complicated product.

Okay, so ISAs can be a bit confusing to the man in the street (one of my friends revealed yesterday that he assumed you had to save for a minimum of five years, as you do with TESSAs), but their beauty lies in their flexibility. The ISA comes as close as an investment product can to being all things to all men. Let me explain, using three fictitious investors as examples.

1. Norman No-Risk
Norman believes a variable-rate mortgage to be a bit racy; he prefers to fix his repayments every few years for the security of knowing exactly how much he pays. Norman has never bought shares in his life and when Abbey National and Halifax transformed into banks, he sold his free windfall shares as soon as he received them.

Norman has all of his money in instant-access deposit accounts with various banks and building societies, plus some National Savings Certificates. The reason he has dozens of accounts is because he worries about keeping too much money with any one bank in case it collapses. Although he saves most of his income (thanks to a frugal lifestyle), Norman never withdraws any money from his savings.

A while back, Norman's sister, Nelly No-Risk, told him about the joys of cash mini-ISAs. She explained that they are A Safe Haven For Your Cash and pay the best rates of interest free of tax. She helped Norman choose a High Street bank that offered a great rate and instant access (Norman doesn't trust online banking). Now Norman earns almost twice as much interest as before and plans to transfer £3,000 a year into cash mini-ISAs. Nice one, Norman!

2. Harry High-Income
Harry set up and ran his own successful business until he sold it and retired in his early fifties to live on the proceeds. The years have ambled by very comfortably for Harry, but he now has a problem. His capital doesn't earn him as much as it used to, thanks to the lowest interest rates since 1955. With the base rate currently at 3.75%, Harry's income is less than half of what it was when he retired and base rates were over 8%.

Harry has no debts, but the upkeep of his homes, cars and yacht is placing a strain on his finances and forcing him to cut back on the little luxuries. Then a friend at the golf club, Brigadier Billy Big-Hat (retired), whose Foolish daughter helps him with his financial affairs, explains that both Harry and his better half can put £7,000 every Tax Year into maxi-ISAs.

They can then invest this money in corporate bond funds, which pay a reliable high income far in excess of the 3.5% Harry's earning on his cash. Harry and Mrs Harry are now whacking away £14,000 between them into maxi-ISAs every Tax Year, and look forward to rediscovering life's little luxuries. Hurrah for Harry!

3. Fiona Fool-Fan
Fiona is a very sensible woman. She worked hard at school, avoided getting into debt at university and passed her law exams with flying colours. She's now a young lawyer and keen make her money work as hard as her (which is pretty hard, let me tell you).

Fiona has no debts and, with the help of her parents, has bought her first home in Leeds. She has a big pot of cash in mini-ISAs as "rainy day" money and a generous final-salary company pension scheme, and now wishes to invest for the long term.

She decides to start open a maxi-ISA and start investing in the stock market, as she's learned that shares are the best long-term investment. Wary of picking her own shares, she decides to invest in a fund to spread her money around.

Unhappy with the outrageously high charges levied by managed funds, she decides to invest in a low-cost index tracker. Foolish Fiona's done her homework (she's a star pupil) and knows that, over the long term, 80% of professional fund managers fail to beat a simple index tracker.

Fiona starts by saving £25 a month, increasing this repeatedly until she hits the maximum £583 a month (as a result of her smooth rise toward partnership in her law firm). Full marks, Fiona!

So, you could criticise ISAs for being too complex, but I would praise them for being flexible enough to meet the needs of Norman, Harry and Fiona – three very different investors with widely varying needs.

Learn more at our ISA Centre.