Helping cash savers see the need to invest
O&M Systems’ MD Graham Miller uses an update to the software to demonstrate the significant variation in returns that can be generated simply by moving from a cash to a general investment ISA.
I think it is fair to say that cash ISA savers will share a number of the following traits:
• They are probably over 50 and don’t like risk.
• They probably don’t switch providers very often.
• They probably don’t realise that loyalty to their ISA providers means they’ll be getting lower rates than new investors.
• They probably couldn’t tell you the rate they are getting currently.
• They probably don’t understand how inflation affects their returns.
Despite this, they’ll almost certainly top-up their cash ISA before 5 April, to make “full use” of their tax free allowances.
Ignoring the current allowance of £15,240, even savers sticking to the 1999 launch maximum of £3,000, will have over £50,000 squirrelled away ignoring interest. For some, this is cash that will probably never be spent and will flow down to their kids. The challenge, is getting them to understand the ongoing real-terms loss they are making and encourage some (definitely not all) of this cash to be ‘invested’ rather than ‘saved’.
Cash ISAs used to work quite well
In April 1999, the landscape for a cash ISA was very attractive:
Average ISA Savings Rate 6.39%
Inflation (RPI) 1.60%
Tax Free Real Returns 4.70%
However, now the landscape is very different*:
Average ISA Savings Rate 0.86%
Inflation (RPI) 2.20%
Tax Free Real Returns -1.30%
Every client will understand that rates have fallen in recent years, but very few realise just how low their rates are currently. It’s unlikely that many of those who are about to top up their cash ISA pot, appreciate the true picture.
The FCA raised the issue of expressing adviser charges in pounds and pence in 2013, so expressing the potential returns from a cash ISA in a similar way would perhaps be useful. The problem is that ISA providers aren’t required to produce projections in the same way that you’d illustrate a pension. Perhaps they should?
Having just added ISA products to our entry level Essentials product, it’s possible to compare the likely returns from three ISA alternatives at once. The example that I’ve used compares £50,000 being saved as follows:
- Option 1 – A Cash ISA assuming a 1% return and no adviser charges. Arguably even 1% is too high, but this is 10 year projection.
- Option 2 – A Stocks and Shares ISA at the lower growth rate of 2% with adviser charges
- Option 3 – A Stocks and Shares ISA at the mid growth rate of 5% with adviser charges.
With £50,000 invested and a growth rate of 1%, the cash ISA grows to £55,800, but in real terms this might be £42,400 a loss of £7,600 in real terms. The middle column is a Stocks and Shares ISA using the lower growth rate of 2%. It delivers very similar results due to the fund, product and adviser charges being taken. The final column represents a Stocks and Shares ISA with similar adviser charges but the mid-rate growth of 5%.
The cautious over 50’s won’t take on risk, for fear of losing money, but every year they are losing money. I don’t anticipate thatvast numbers will become investors overnight, but these reports take minutes to produce, so there’s no harm in showing them their true loss. You can use this link to find the client facing report.
[* Rates taken at end of 2016.]