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George Osborne’s ISA Illusion, And Why It’s Still Better To Invest In The FTSE 100

At first blush, the Budget looks great for savers. The first £1,000 of interest will be tax free (reduced to £500 for higher-rate taxpayers), and ISAs will be made more flexible, so money once withdrawn from an ISA can be put back in again without losing any of the tax-free entitlement.

But hang on a moment. With the best interest rates under 2%, you need to be a basic-rate tax-payer with at least £50,000 of cash savings to get the maximum benefit — which would be precisely £200 a year. Higher rate taxpayers will get the same benefit with £25,000 of savings. But scale it down to most people’s actual level of savings, and it doesn’t add up to much.

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More importantly, perhaps, is that it will make cash ISAs pretty much redundant for basic-rate taxpayers. You’ll be able to save cash in a non-ISA account and still not pay tax on the interest.

Flexibility vs discipline

So the new flexibility for stocks and shares ISAs is great, no? I’m not so sure. We often say here at The Motley Fool that investing to build your wealth is at least as much a matter of discipline as it is expertise. And I for one appreciate that my reluctance to give up the tax benefit has helped me avoid temptation to withdraw money that I’ve put away to grow.

Today’s tax changes ignore three fundamental facts about investing:

  • Stocks and shares have, historically, proved to be far and away the best way to store and grow wealth over many years. Inflation eats away at cash. According to Barclays, over the past 100 years shares have produced an average annual return of 5.1% over inflation, whilst cash savings grew just 0.8% a year;
  • You need to invest in shares for many years to get the benefit of reinvested dividends, which account for much of the growth in value of a share portfolio;
  • Share prices are volatile, so stocks are not good places to invest money you might be tempted to spend.

Grow your wealth

It’s still the case that one of the best ways to grow your wealth is to feed money into the stock market as and when you can, and to do that in an ISA so that you build up returns tax-free. A low-cost FTSE 100 index tracker is a straightforward way to start. The index has returned 9.6% p.a. over last three years and 9.1% p.a. over the last five.

If you’re interested in individual shares then there are plenty of high-quality, high-yielding stocks to choose from. Eighteen — nearly one in five — of the FTSE 100 stocks are currently yielding 5% or more.

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Tony Reading has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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