Innovative Finance ISAs, or IFISAs, haven’t been around for long, but they’ve already made a name for themselves.
Unlike traditional Stocks and Shares ISAs and cash ISAs, these instruments allow you to use peer-to-peer (P2P) lending platforms to loan money and earn the interest.
With returns of up to 7% per annum available, IFISAs look exceptionally attractive compared to traditional cash ISAs. Indeed, most cash ISAs on the market today offer interest rates of less than 2%.
However, IFISAs are not risk-free and I’m going to explain why I believe the FTSE 100 might be a better way to invest your funds.
Not risk-free
A return of 7% or more on your money might seem attractive, but this return comes with a caveat. You could end up losing some of your money.
P2P lending platforms match lenders (investors) with borrowers and operate in much the same way as a traditional bank. This also means investors are exposed to losses.
The average default rate on loans across most platforms sits in the range of 3-4%, although the theory is that interest received offsets these losses. Most platforms also have a reserve fund, which fills the same role as a bank’s capital reserves. This is a sort of insurance fund for investors who end up with bad loans.
But there’s a massive problem with this model. As yet, most P2P lenders haven’t been through a recession, so we don’t know what sort of losses investors will experience if the economy tanks.
With this being the case, I think it might be best for investors to avoid P2P lending and IFISAs altogether. In my opinion, returns of 4-7% per annum aren’t enough to compensate for the risk of losing 100% of your investment.
A better buy
In comparison, the FTSE 100 supports a dividend yield of 4.6% at the time of writing. This is an average of all the companies in the index, 100 of the UK’s top businesses rather than small businesses, startups and individual borrowers.
Furthermore, over the long term, the chances of you losing 100% of your investment by investing in the FTSE 100 are virtually zero. For this to happen, every single company would have to collapse, companies such as Unilever and Royal Dutch Shell, which are the biggest businesses in their respective fields in the world.
Not only does the index provide a higher level of income but, over the past decade, it has also achieved better returns than P2P lending. According to my research, over the past 10 years, the FTSE 100 has produced a return for investors of approximately 9% per annum, that’s including income and capital growth.
So, that’s why I would avoid IFISA’s and buy the FTSE 100 instead. Not only does the UK’s leading blue-chip index support a higher level of income, and has achieved better returns over the past 10 years than P2P lending, but it also comes with less risk of a capital loss.
