How to inflation-proof your ISA

If you want earn yourself an inflation-busting nest egg, a cash ISA might be best avoided. Here’s an alternative that could do a lot better.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

ISA season is once again upon us, and with a new allowance of £20,000 that we can invest tax-free, the banks and building societies are starting to pitch their cash ISA offerings.

Looking round the comparison sites and at the interest rates on offer, I can see why folks might not exactly be biting their hands off — the best rates are only around 2.25%, with many offering little more than a pitiful 1%.

When UK inflation is currently running at around 3%, that won’t even retain the value of your savings, never mind grow them over time. 

In my view, the cash ISA is one of the worst investment products ever (among legal and honest ones, at least) and is a complete waste of time.

Yet in the 2016-17 tax year, UK investors shovelled £39bn into cash ISAs — although that was one of the lowest amounts in recent history, with the total down from a staggering £59bn the previous year.

Cash is a loser

I am, at least, pleased that UK savers appear to be realising that a cash ISA is very poor value. But it still pains me to read of so much money heading in such a poor direction, when there really is a far better opportunity out there — one that is likely to wipe the floor with cash investments and blow away inflation into the bargain.

I am, of course, talking of a Stocks and Shares ISA (where “stocks” and “shares” are really just two words for the same thing.) With one of those, you still get the same £20,000 allowance, but you get to invest it in shares instead — and that’s fairly widely interpreted to allow various funds, like investment trusts, which can make the selection process a good bit easier.

If you want to pick your own shares, there are plenty of approaches. My favoured ISA strategy is to buy shares in FTSE 100 companies paying good dividends, spreading the cash across different sectors for a bit of diversification.

But what kind of returns can you hope for if you invest in a shares ISA?

Well, the FTSE 100’s average dividend yield is standing at around 4.3% at the moment, and that trounces those horrendously low cash ISA interest rates — and that’s before you even consider any possible share price gains.

Beating the risk

You might think shares are a bit too risky for you and that you could lose money. That is true, you might. But the longer you invest for, the better are your chances of coming out well ahead.

The people at Barclays have been studying the records since 1899, and they’ve discovered that over rolling 10-year periods, shares have outperformed cash 91% of the time. Extend that to 18-year periods and the figure jumps to 99%. And if you stretch to 23-year periods, cash has never beaten shares even once — and that even includes the great crash of 1929 and other financial catastrophes.

In fact, the Barclays study calculates that £100 invested in UK shares in 1945, with dividends reinvested in new shares, would have grown to almost £180,000! And that’s after adjusting for inflation.

So yes, you can use an ISA to beat inflation, and possibly by a very handsome margin — by going for a shares ISA instead of a cash ISA, and holding for the long term.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

4 REITs Fools own for passive income

REITs often have higher-than-average dividend yields compared to other stocks, making them a solid choice to consider for passive income…

Read more »

artificial intelligence investing algorithms
Investing Articles

Up 272% in just a year, is Palantir stock just getting started?

This writer recognises that Palantir has grown its business very well -- but does the stock price offer him an…

Read more »

Runner standing at the starting point with 2025 year for starting in new year 2025 to achieve business planing and success concept.
Investing Articles

Up 50%? The Aston Martin share price forecast is mind-blowing! 

If analysts are right, the Aston Aston Martin share price could absolutely rocket in the year ahead. Harvey Jones says…

Read more »

Investing Articles

As the S&P 500 drops, here are 2 Stocks and Shares ISA holdings I’m watching

Our writer has different views on how President Trump's tariffs might affect these two US holdings in his Stocks and…

Read more »

Surprised Black girl holding teddy bear toy on Christmas
Investing Articles

£10,000 invested in Tesla stock at Christmas is now worth…

Tesla stock has been one of best-performing investments of the past decade. But things haven't gone to plan for investors…

Read more »

Investing Articles

Up 279% in 5 years, could Meta stock keep soaring?

Meta stock has more than tripled in five years. This writer sees lots to like about the business but also…

Read more »

Pink 3D image of the numbers '2025' growing in size
Investing Articles

25% total return in a year? Is now the perfect time to buy BP shares?

BP shares are on the front line of today's global economic and political uncertainty but analysts think they can still…

Read more »

Affectionate Asian senior mother and daughter using smartphone together at home, smiling joyfully
Investing Articles

With Cash ISA changes coming, could now be the time to consider buying shares?

Changes to the Cash ISA could lead to greater investment in the stock market. This could be a good thing…

Read more »