Inflation Threat To Cash ISAs

UK CPI inflation in February rose sharply once again, reaching 6.2%. Last month it was 5.5% and a year ago it was 0.4%

Inflation continues to increase and looks set to stay with us for some time. There has never been a better time therefore to review your existing Cash ISAs.

Inflation can be good for holders of assets, if their values rise faster than the general level of inflation. This typically includes property, commodities and shares.

However, it is generally bad for anyone with a fixed income and possibly worst for cash deposit holders, the ultimate tax on savers.

The graph below illustrates how the value of £100 in your pocket could have been eroded by the effects of 1%, 2% and 5% inflation over a 10 year period.

Figures announced today confirmed inflation rose to a 30 year high last month. The ONS said the consumer price index [CPI] rose at an annual rate of 6.2% in February, up from 5.5% in January.

This is a further blow to savers who continue to endure historically low interest rates. Data obtained by consultancy LCP found that more than three million pensioners hold all of their ISA savings in cash.

Even a relatively generous 1.35%* interest rate in a Cash ISA would see pensioners lose 4.85% of their spending power over a 12-month period.

*this is the current best rate for a one year fixed with Shawbrook Bank, the next best is 1.2% with Close Brothers [as at 23.03.22]

Applied to the £87bn held by cash-ISA-only pensioners, this implies a £4.2bn hit in a single year on the real value of pensioner savings.

The average ISA savings of over-65s was £52,500. The figures found that 3.4m of over-65s held an average £25,383 exclusively in Cash ISAs.

Women over-65 were slightly more likely than their male counterparts to have large cash-only balances, with 293,000 women keeping £50,000 or more in cash compared with 273,000 men.

While rates higher than the above 1.35% can be achieved by fixing for longer (the best 5 year fixed being 1.9%) I wouldn’t be locking into a 5 year deal any time soon.

I find a significant number of new clients hold Cash only ISAs to the exclusion of Stocks & Share ISAs.

Most express the desire to achieve a higher return and when a transfer to a Stocks & Share ISA is suggested, a normal response is they don’t want to take that level of risk.

There is a common misconception that ISAs exist on only two levels, 100% Cash (safe) or 100% Stocks & Shares (not safe).

That may be correct from a product name perspective, but not when looking at the available underlying asset options.

Cash ISAs can hold only cash, that much is true.

Stocks & Share ISAs however have almost unlimited investment options and can be 100% cash, 100% stocks & shares and every combination in between. You do not have to be fully exposed to stock market returns to potentially receive returns well in excess of cash.

The chart below shows returns over the last 5 years from portfolios with differing allocations to shares [0% (i.e. 100% cash), 20%, 40%, 60%, 80% and 100%].

As you can see, even taking account of the volatility, every portfolio has comfortably beaten cash returns.

What about investing at a market high? The chart below shows investment just prior to the Covid market crash in February 2020 and also includes the recent falls at the start of this year. Again, most portfolios have beaten cash, and the 20% equity portfolio is still in positive territory. Of course, past performance is no guide to future returns and you should always seek advice if you are unsure.

Stocks & Share ISA are just as accessible as Cash ISAs and if your Cash ISA represents a part of your long term savings for the future as opposed to your short term emergency funds, perhaps it could do with a spring clean.