The case for investing your excess cash

For months, the betting has been that the Chancellor, Rachel Reeves, will reduce the amount you are allowed to put into a cash ISA each year, while leaving the overall allowance at £20,000. But in the Mansion House speech last week she decided against making this change.

There is no doubt cash ISAs are popular, with around £300bn held in these tax-free savings accounts. But the Chancellor is concerned that by offering tax perks to people putting cash in the bank or building society, she is giving them a reason to avoid stock market investment – and therefore depriving businesses, including UK companies, of much needed capital. Reeves figures that if she reduces the cash ISA allowance, she might persuade more people to put excess savings into stocks and shares ISAs, which are a tax perk too.

Views differ on the pros and cons of this approach. For example, the savings industry argues that if banks and building societies attract less money from cash ISA savers, their ability to fund mortgages and other lending will be adversely impacted, which would be bad news for the UK economy.

However, these arguments shouldn’t preoccupy individual savers and investors. The only relevant question for them is where it is most appropriate to hold their money.

Clearly, for same people, cash ISAs are the right move. If you don’t have an emergency buffer of savings, you should be trying to build one – and a cash ISA is a good home for that backstop.

Equally, if you’re going to need access to your money in the short-to-medium term – to fund a property purchase or pay for kids’ education, say – you can’t afford to have it in investments that can fall in value as well as rise. Again, cash ISAs are going to be a better option than a stocks and shares ISA.

That said, once your short-term savings are in good shape – and £20,000 a year is a significant chunk of savings for most people – cash ISAs start to look less and less attractive, especially since so many cash ISA accounts pay rates of interest well below the rate of inflation. With stocks and shares ISAs, however, there is the potential, albeit with no guarantees, to produce much better returns over time.

For example, according to Capital Economics, £100 invested in cash deposits in 1985 would have grown to about £150 in real terms over the past 40 years. In other words, its spending power would have grown by approximately 1.5 times over those four decades (and since 2010, it would actually have been shrinking as inflation has exceeded interest rates).

However, a £100 investment in the FTSE All Share, with dividends reinvested, would have grown more than sixfold in real terms. That is, a sixfold increase in spending power.

It’s a mistake to assume that the choice here is between an ultra-low risk account and something super high-octane. The Flexible Investment sector of the investment trust universe contains a bunch of trusts with a mandate to invest across multiple asset classes – including equities, bonds, property and more – to generate returns for investors.

Many of these funds have an explicit objective to protect investors’ cash from downside risk; their goal is to grow your money without taking risks that could lead to significant losses. Examples include Capital Gearing Trust, Personal Assets Trust and Ruffer Investment Company. All have a proven long-term record of preserving capital even during the most turbulent of times on the stock market while outperforming cash.

Such funds won’t be right for everyone, but they could be a good stepping stone into the world of stocks and shares ISAs. Whatever the government finally decides, it makes sense for most savers to at least look beyond cash ISAs – there may be much more on offer than you realise.