The Individual Savings Account (ISA) is a fantastic tool to help Brits build long-term wealth. As a saver or investor, I don’t pay a penny in tax on interest, capital gains, or dividends, which in turn could potentially boost my retirement fund by tens — or even hundreds — of thousands of pounds.
Having said that, not all ISAs are created equally. Put simply, the difference in returns one can expect to make from a Cash ISA and a Stocks and Shares ISA is colossal.
And over time, the choice I make between these two can have a significant impact on my standard of living in retirement.
Cash vs shares
Holding money in a savings account has some big advantages, no doubt. It’s hassle free — savers don’t need to trouble themselves with researching and then buying shares, trusts, funds, or other exchange-traded assets.
On top of this, cash savings offer security, as they are immune to the volatility of stock markets.
Having said that, these benefits come at a huge price. According to AJ Bell, the average rate of return for a Cash ISA over the last 10 years is 1.2%.
To put that in context, the corresponding return on a Stocks and Shares ISA towers over this, at 9.6%.
Let’s see the difference these differences could make on an investor’s wealth-building capabilities over the long term.
If someone was to invest £300 in a Cash ISA each month, they would — after 30 years — have £129,921 in their retirement fund. That’s far below the £622,924 that a Stocks and Shares ISA could have made over the same period.
A top fund
As I say, a Cash ISA allows individuals to essentially eliminate capital risk and volatility. Yet it’s critical to note that Stocks and Shares ISA holders can also, with the right approach, effectively manage risk to their money.
This can be done by building a balanced portfolio of shares spanning different industries, sub-sectors, and geographies.
A quick and easy way to achieve this can be by buying an exchange-traded fund (ETFs) that holds a basket of assets. Based on past performance, the iShares FTSE 250 ETF (LSE:MIDD) could be a top one to consider.
Since its creation almost 21 years ago, this fund’s delivered an average annual return of 8.5%. Combined with some ‘riskier’ individual shares, investors could have a good chance of hitting (or even exceeding) that 9.6% Stocks and Shares ISA average return.
This iShares ETF provides investors with attractive growth and dividend potential. Its focus on mid-cap stocks has produced healthy capital gains driven by earnings expansion. A forward dividend yield above 3% also provides a healthy passive income.
At the same time, its 250-odd holdings spanning sectors like financial services, consumer goods, and real estate help to diversify risk by reducing exposure to any single company or industry.
The fund this can still dip when economic conditions worsen and broader stock markets dip. But while past returns aren’t a reliable guide to the future, I’m optimistic it will keep providing a Cash ISA-beating return over the long term.
