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3 reasons why I think cash ISAs are a bad idea

The end of the tax year is rapidly approaching, If you haven’t made the most of your ISA allowance for this year, now is the time to start doing so.

ISAs are a great tool for investors, particularly higher rate taxpayers, as any income or capital gains generated within an ISA wrapper is entirely tax-free. You don’t even need to declare your ISA on your tax return.

What’s more, in recent years, the government has introduced a range of new ISA products including flexible ISAs, LISAs and Innovative Finance ISAs, all of which are designed to give investors as many options as possible when it comes to saving.

However, despite all of the new options available, figures show that many investors are still relying on vanilla cash ISAs, rather than seeking out higher returns elsewhere. 

Poor returns 

The highest interest rate offered by a cash ISA today is 1.5% (although you can get more if you are willing to lock your money up for longer).

Meanwhile, you can achieve a return of 6% or more by investing in an Innovative Finance ISA, which gives investors access to a basket of peer-to-peer loans. If you invest in the Stocks and Shares ISA, you could have a return of 7-10% per annum, just by investing in a simple FTSE 100 or FTSE 250 tracker fund, based on historical average returns.

Low returns are just one of the reasons why I think cash ISAs are a terrible idea. I also think many cash ISA products are a bad idea because they are so inflexible. 

Lack of options 

A few years ago, the government removed the stipulation that Stocks and Shares, and cash ISAs had to be kept separate. Following this change, investors can now hold cash in former, giving them flexibility when it comes to deciding how much to invest in the market and how much you want to be keeping cash for emergencies. 

Unfortunately, many providers who offer cash ISAs don’t offer investments as well, which means savers’ options are limited — you are effectively resigning yourself to a lifetime of poor returns.

Money restrictions 

The third and final reason why I think cash ISAs are a terrible idea is the fact that to get the best returns on your money, you have to be willing to lock your funds away for several years. 

For example today, you can get a return on your money of 1.5% from an easy access cash ISA. However, if you’re willing to lock your money away for five years, you could see a return of 2.3% per annum. 

The extra 0.8% per annum in interest might seem attractive at first glance, but when you lock your money away, you have to be sure that you won’t need these funds in the near term. If you do, you could be hit with severe penalties when you try to get your money out.

Personally, don’t think this risk is worth taking for an interest boost of just 0.8%.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.