There’s been plenty of speculation about the Chancellor’s plans for the upcoming Budget, but one of the most persistent rumours has been that she has cash ISAs in her sights. The theory is sound – encourage investors to move out of low-paying cash accounts and into stock market ISAs, thereby supporting the economy and – hopefully – delivering a higher return. Everyone wins.
It is certainly true that cash ISAs do little to support economic growth. Moves to reform them were backed by more than 50 tech founders and bosses, who also want to see better incentives for investing in companies: “While a reduction in the tax-free allowance for cash ISAs may encourage more investment, it will only be effective if introduced alongside new investment routes that ensure redirected savings genuinely support British innovation,” the group said.
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How much cash is too much?
The trouble is, cash ISAs are popular. In the 23/24 tax year, around £27.9bn was subscribed to cash ISAs. At £3.1bn, stocks and shares ISA subscriptions were a fraction of the total*. The Chancellor may be able to reduce cash ISA limits, but encouraging investors into the stock market may prove trickier.
The Chancellor is right that many people probably hold too much in their cash ISAs. Although interest rates on savings have improved, they are still only marginally ahead of inflation. The rule of thumb is that people should hold enough cash to cover around three to six months’ worth of household expenses, and everything else should be in higher-growth assets.
Why stocks and shares ISAs offer greater value
Equally, the tax benefits of an ISA are far more valuable when investing in stocks and shares. Investors need a cash balance of around £40,000 before they are likely to exceed the £1,000 tax-free savings allowance (or £500 for higher rate tax payers) and won’t need the capital gains tax advantages of an ISA. For growth assets, such as equities, these become more important.
The danger is that those investors who do move away from cash go straight into high-risk, highly-valued areas such as AI or the US stock market. While the jury is still out on whether AI is in a bubble or not, there have certainly been better times to invest. We would suggest some gentler options for those shifting money out of cash ISAs.
Four funds to get you started
If investors are happy with stock market risk, a global equity income fund can be a good starting point. It is worth picking one that is genuinely diversified so it will not be too exposed to any volatility in the American market.
The Fidelity Global Dividend fund, for example, has a good balance across different economies – the US is still the portfolio’s largest weighting, but at around 25% rather than 70%+ for the MSCI World**. The fund has around 13.5% in the UK, another 10.1% in France and 8% in Switzerland. The yield of 2.5%** won’t set pulses racing, but it is a stabilising factor over time.
If all stock markets feel a little spicy for the time being, a good corporate bond fund may fit the bill. Although spreads over government bonds are low by historic standards, the ‘all-in’ yield is still attractive and provides a good ballast against difficult markets. The Artemis Corporate Bond fund, for example, pays around 5%***, with the potential for capital growth. It is managed by a capable team, led by Steven Snowden, with a track record of careful bond selection.
Strategic bond funds are another option. These have the flexibility to roam across fixed income markets looking for value. In today’s febrile economic climate, this agility is valuable. The TwentyFour Dynamic Bond fund is run by a skilled specialist team and is one of the top performers in its sector over the past three years^.
Another option might be the TM Gravis UK Infrastructure Income fund. This is designed to deliver regular income, preserve capital and protect against inflation. The fund currently has a yield of over 6%**, which makes it a compelling alternative to both cash and bonds. Infrastructure has been in the doldrums recently, so investors also have the potential for a revival in the sector.
Most people are likely to benefit in the long term from moving away from cash, but the leap from cash ISA to a more volatile stock market fund may be a step too far. These funds could be staging posts as more people embrace stock market investment.
