ISA inflows are booming! But are savers making a fatal mistake?

We’re huge fans of the Individual Savings Account (ISA) here at The Motley Fool.

With generous annual allowances — £20,000 for both the Cash ISA and the Stocks and Shares ISA — and protection from capital gains and dividend tax, they provide an excellent way for Brits to build long-term wealth.

So recent data showing that savers are turning their backs on standard savings accounts for ISAs is encouraging.

But on the other hand, could people be missing a trick by prioritising Cash ISAs over their share-based equivalents?

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

The ISA boom

Studying data from savings specialist CACI, Paragon Bank calculates that adult ISA cash balances totalled £359.2bn as of September. This reflects growth of 11.7%, or £37.7bn, since the end of January.

By comparison, balances on non-ISA savings accounts have risen by a modest £0.4%, or £3bn.

Paragon says that “savers have increasingly focused on ISAs as savings rates have moved higher, leaving more exposed to potential tax bills“.

These tax liabilities are quite shocking too. Using figures from HM Revenue and Customs, it notes that “£10.4bn is expected to be generated from savings interest in the 2024/25 tax year, ten times the £1.4bn raised in the 2021/22 tax year.”

Big mistake?

While the rise in ISA activity is a good thing for investors, I still worry that savers are making a big mistake, one that could cost them a comfortable (or even luxurious) retirement.

Although Cash ISAs can save individuals a fortune in tax, the returns they offer are poor compared with those that a Stocks and Shares ISA can provide. And with interest rates coming down, the savings rate on Cash ISAs is following suit.

Making better returns

I own both a Cash ISA and Stocks and Shares ISA. But the amount of my money invested in the latter is far higher. Let me show you why.

If someone invested £250 a month in a 5%-yielding Cash ISA, after 30 years they’d have a retirement pot of £208,065. By comparison, if they’d put that in a Stocks and Shares ISA providing an average annual return of 9%, they’d have a balance of £457,686.

Past performance is no guarantee of future returns. But history shows that an equal mix of FTSE 100 and FTSE 250 shares could allow me to hit that 9% target.

Targeting trusts

Buying shares rather than holding cash on account involves greater risk. But purchasing a trust like the F&C Investment Trust (LSE:FCIT) can significantly reduce the danger.

Dating back more than 150 years, this particular trust clearly has a strong record of delivery. In fact, with an average annual return above 11.4% since 2014, it’s provided a better return than both FTSE 100 and FTSE 250 shares.

In total, the F&C Investment Trust has holdings in around 400 countries across the globe. And so it offers investors excellent diversification across different industries and regions.

The trust has a larger weighting of tech stocks like Nvidia and Apple than some others. This could impact total performance during tough times when consumers and businesses trim spending. However, it also provides exposure to rising growth sectors like artificial intelligence (AI) and quantum computing.

On balance, I think it’s a great investment to consider for a Stocks and Shares ISA. It’s just one of many top trusts to choose from today.