Why cash ISA rates are no joke

ISAy ISAy ISay… Did you hear the one about the man who invested tax free… and lost money? The interest rates payable to savers are looking more than ever like a joke, and it seems likely that the experience of 2015 will be repeated this year. For instance, cash ISA savers will not have been happy to see NS&I slash its Direct ISA rates to the lowest ever (1.25 per cent) in November last year. Previously, that particular ISA had been at the top of the best-buy tables.

Even though the Bank of England's base rate has remained at 0.5 per cent, ISA rates across the industry have tumbled. TSB cut rates on 11 December, and some HSBC customers are receiving letters about a reduction.Even more recently, the government announcement that the rate of interest on pensioner bonds has been slashed by nearly 50 per cent highlights that, actually, this joke isn’t funny at all.

The Bank of England Base Rate has remained at 0.5 per cent for around six years. The current expectation, following the US Fed’s decision to raise rates in December 2015, is that interest rate rises for the UK are most likely to occur from Q2 onwards. At the same time, we will be seeing inflation start to come back in as energy price reductions work their way out of the calculation.

So with low interest rates for some time ahead, and mild levels of inflation, the need to make investments work hard has never been more important. An additional thought here: a tax-free ‘low risk’ investment that in real terms loses money would, in any other product, surely have been the subject of millions of mis-selling complaints and government enquiries!

The chart below highlights this dual problem of low interest rates and moderate inflation, simply by comparing RPI, CPI and the Bank of England Base rate over the last 6 years.

For savers caught in this position (and there are millions) there are alternatives to consider.

Let’s look at the numbers affected

  • £79bn was subscribed to adult ISAs in 2014-15
  • £483bn was the market value of adult ISA holdings at the end of the 2014-15 tax year and around £237.5bn was held in cash ISAs.

Source: HM Revenue and Customs ISA statistics 2015.

So what is the alternative for clearly risk-averse investors?

One option could be the Prudential Stocks and Shares ISA with access to PruFund funds. Although it carries more risk than a cash ISA, it could well be seen as a ‘halfway house’ for cash savers who are not necessarily willing to take the plunge fully into equity markets, yet do recognise that they will need to take more risk to achieve real returns in excess of inflation,

Prudential’s track record of multi-asset investing, the wide diversification of assets within the PruFund funds, and the added comfort of the smoothing process can make the move from cash to multi-asset investing a much easier decision for many.

On that note, it’s time for another joke. Did you hear the one about the stocks and share ISA investors who didn’t review their investments?

Stocks and shares ISA investors choosing a single asset class, such as UK equities, have benefited from attractive returns over the last six years. The use of multi-asset investments has dampened this roller coaster effect a little.

The truth is that the world is not getting any less volatile and continuing 'shocks' to markets will inevitably occur, whether they be natural disasters, political (Brexit), market (recessions/slowdowns) or legislative (government policy changes).

The question, I guess, for those investors seeking the higher returns from risk-based assets, is this. Is now the time to consolidate my gains into a more risk-averse investment solution, while continuing to benefit from actively managed multi-asset funds, with the added overlay of a smoothing mechanism? The market volatility just prior to Christmas will have brought this question into sharp focus once again.

When you couple this with the need to manage clients’ income from multiple tax wrappers in the new world of pension freedom, and the need to manage pension death benefits, an investment that provides some protection from pound cost ravaging can be a welcome home for consolidation.

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