The Individual Savings Account (ISA) has saved investors billions in tax since 1999. Whether investing in UK shares or holding cash on account, the benefit to investors comes to tens of billions.
Yet while the wealth-boosting advantages of ISAs are clear, many people fall into the trap of regularly investing and expecting to automatically have a large pension pot at the end of it. Putting money in the ‘wrong place’, according to one’s investing goals, can have devastating effects in retirement.
Let me show you how.
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Savings rates
Putting money in a Cash ISA can be a great option to consider for investors looking to manage risk.
The problem is that tens of billions of pounds are currently locked up in ultra-low-yielding accounts. According to Paragon Bank, a whopping £54.1bn is held in easy access and fixed-rate ISAs with an interest rate of 2% and below.
Given that the best-paying easy access Cash ISA (from Chip) currently pays 5.03%, savers are potentially missing out on substantial sums over the long term.
An ISA with a 2% interest rate would, on a £500 monthly investment, deliver £194,411 over 25 years. That 5%-plus paying one would provide a far superior £299,092.
A better return
It therefore pays to consider switching provider, then. But it’s also important to remember that putting too much money in a Cash ISA can also be a mistake.
This is because the return on one of these products may not generate a large enough retirement passive income. If someone drew down 4% from their £299,092 Cash ISA each year, they would have an annual passive income of £11,964 for around two decades.
Even combined with the State Pension, this may not be enough for many of us to retire comfortably.
Investing in a Stocks and Shares ISA as well as a Cash ISA can help solve this problem. I myself invest the lion’s share of my money in UK shares, trusts, and funds to get a better return, with a lower amount held in cash to balance risk.
I’ll show you why. Let’s say someone invests 80% of a £500 monthly sum in a Stocks and Shares ISA, and the remaining 20% in a Cash ISA paying 5.03%. If they could hit a realistic average annual return of 9% with a Stocks and Shares ISA, they would — after 25 years — have a healthy £508,267 to retire on from both ISAS.
That would, in turn, deliver a £20,331 annual passive income, based on a 4% drawdown rate.
Managing risk
As I say, investing in UK shares is a riskier endeavour. But individuals can reduce the danger by purchasing an exchange-traded fund (ETF) like the iShares S&P 500 ETF (LSE:CSPX).
This London-listed product invests in hundreds of US multinational companies, thus providing excellent diversification by industry and geography. But as well as providing a way to spread risk, a high weighting of technology shares (like Nvidia, Tesla, and Apple) allows investors to target huge returns as sectors like artificial intelligence (AI) and quantum computing rapidly grow.
During the 10 years to February 2025, this fund delivered a tasty average annual return of 12.6%.
Stock-based ETFs like this may decline during economic downturns. But over the long term, they still have the capacity to deliver impressive returns, as this S&P 500 product has shown.
