Why You Really Need To Know The Difference Between A Cash And Investment ISA

Our brains are so bombarded with information these days, it’s hard to retain it all.

Sometimes, we never quite clear up some minor detail, such as the difference between a cash ISA and a stocks-and-shares ISA.

So we carry on, vaguely stumped, and hope it doesn’t matter.

But if you plan to invest money in a tax-efficient ISA (and I recommend you do), that minor detail could end up costing you thousands of pounds.

Or rather, £1,278 a year, to be precise.

Piggy bankSimply Staggered

That’s how much you can lose by failing to tell the difference between a cash and investment ISA, according to new figures from Scottish Friendly.

Which is worrying, given that half the country can’t tell the difference between the two.

Scottish Friendly call it “a staggering lack of understanding”.

Browned Off

Personally, I’m far from staggered. When former Chancellor Gordon Brown launched ISAs in 1999, he made them unnecessarily complicated (that was one of his trademarks).

I won’t bore and confuse you with the original rules, because life is too short, and anyway, they’ve been simplified.

But the division between cash ISAs and stocks-and-shares ISAs still exists, and you need to know what it means to you.

How A Cash ISA Works

A cash ISA is very much like a standard savings account. They are issued by banks and building societies. Your money is safe, plus you get a little interest on top each year.

The key difference is that you take all that interest free of income tax. 

What A Stocks-And-Shares ISA Does

An investment ISA, or stocks-and-shares ISA, is both riskier and a little trickier to understand.

When you buy a stocks-and-shares ISA, you typically buy an investment fund that pools money from thousands of investors and uses it to buy stocks and shares.

Because your money is invested in the stock market, your original capital isn’t guaranteed. When stock markets fall, so does the value of your money.

And when markets rise, your money should follow.

Again, your returns are free of income tax, and capital gains tax.

The £15,000 Question

Currently, you can invest up to £11,880 into an ISA. From 1 July, that increases to £15,000.

Of course, you can start with smaller amounts. 

The rules have also been simplified. You are now free to put your full £15,000 into a cash ISA, if you wish. Or you could put it all into a stocks-and-shares ISA.

This bigger allowance makes it more important than ever to understand the difference between the two.

Pound CoinsShares Turned £1,000 into £2,286

People are far more likely to take out a cash ISA, because they are more familiar, and safer.

The problem is that in the longer run, stocks and shares should make your money work much harder.

Scottish Friendly’s figures show that £1,000 paid into the average tax-free cash account five years ago would be worth just £1,008 today.

The average UK investment ISA would have returned £2,286.

That’s £1,287 more.

It would have been a lot, lot more if you had invested £15,000.

So you really do need to know the difference between the two. Because it could run to thousands of pounds.

Retain This One Fact

Stocks and shares won’t always outperform quite so dramatically. These have been a dismal five years for cash, and a strong five years for stock markets.

But if you are prepared to invest for the longer term, a stocks-and-shares ISA should be a far more rewarding place to leave your money.

And that is definitely a fact worth retaining.

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Harvey Jones doesn't own shares in any company mentioned in this article