Understanding the risks and returns of an IFISA and Stocks and Shares ISA

The Innovative Finance ISA (IFISA) and Stocks and Shares ISA are both popular investment products benefited by a tax wrapper, shielding any income made within the accounts from income tax and capital gains tax.

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The IFISA has welcomed over a huge £1 billion worth of investments since its inception in April 2016, while 2.8 million Stocks and Shares ISAs were opened in 2017/18 alone. 

When exploring an IFISA vs Stocks and Shares ISA, two of the most important things you’ll consider are the risks and returns, and the relationship between them. 

The accounts have differing risk/return profiles, and understanding both can help in deciding where to allocate your annual ISA allowance - which is £20,000 for the 2020/21 tax year. 


The potential of high, inflation-beating target returns

One of the most appealing features of both IFISAs and Stocks and Shares ISAs are their high, inflation-beating target returns when compared to a Cash ISA - the deposit account that typically offers interest rates of 2% or lower (1.61% is currently the highest rate available, according to Money Saving Expert). 

The target returns attached to an IFISA vary depending on what’s held within the account (peer-to-peer loans or debt-based securities), but they’re typically around 4-8%+. Again, because of the sheer variety of investments that can be held in a Stocks and Shares ISA, their target returns differ - though they’re often around 4%+. 

Read more:download the IFISA guide

It’s important to remember that these returns are just targeted. Because both the IFISA and Stocks and Shares ISA are investment products, returns are not guaranteed and your capital is at risk. 

Experienced investors are often willing to take these risks though, for the potential of higher returns.


The risks of an IFISA

To match their higher target returns (in comparison to cash deposit accounts), IFISAs also come with a mid/high risk profile.

With an IFISA, the biggest risk you’ll face is that the borrower(s) loaning your funds will default on their loan(s). The reasons for a borrower defaulting on their loans can - and will - vary, often depending on the asset held. 

Your chosen IFISA provider should have processes set up to minimise the risk of loan defaults, with a strong procedure for vetting prospective borrowers. Before investing into an IFISA, it’s advisable that you have a good understanding of these processes. 

Read more:what is the best Innovative Finance ISA available?

There is, however, also a risk that your IFISA provider could go bust, though providers should have a contingency plan in place if this were to happen.

It’s important to note that, in both of these circumstances - borrower defaults and provider failures - no protection from the Financial Services Compensation Scheme (FSCS) is available, as unlike Cash ISAs and Stocks and Shares ISAs (which are covered if the provider fails, but not in the event of poorly performing investments), IFISAs are not covered at all.

Many IFISAs - including those that hold property bonds, green energy bonds and SME loans - are often asset-backed. This means your investment could have first-ranking (or equal first-ranking) security on assets, such as land or property, of the borrowers. 

However, asset-backed security does not completely rid your investment of risk, and it does not guarantee the return of your capital in the event of a downturn in the economy.

Conducting your own due diligence on both the IFISA provider and the underlying borrower is important - along with seeking advice from an independent financial advisor - to make sure that you’re comfortable with where you’re investing your funds, and the risks associated with both the provider and the asset. 


The risks of a Stocks and Shares ISA

Like the IFISA, Stocks and Shares ISAs come with a mid/high risk profile. There are a huge variety of investments that can be held in a Stocks and Shares ISA, and all will have their own associated risks (some higher than others).

One thing to remember about the stock market is that it is volatile, with fluctuations on a daily basis, and for this reason should be considered a long term investment option. This is because you need to give your investments time to ride out any drops in value. 

The stock market doesn’t like uncertainty, and it’s always looking ahead. If something causes decreased confidence in the stability of future investments - for example, wars, natural disasters, technological changes etc. - supply and demand will be affected, causing the market to fluctuate. There will often be an increase in supply (investors looking to sell their stocks and shares in search of a more ‘secure’ investment) and a decrease in demand (because of the negative outlook caused by the aforementioned factors). 

Stocks and Shares ISAs are covered by the FSCS for up to £50,000 if your authorised provider failed between January 1st 2010 and March 31st 2019, and up to £85,000 if the failure occured after April 1st 2019. This FSCS protection only protects investors from provider failure though, and does not cover poorly performing investments.


Coronavirus (COVID-19) and a volatile stock market 

We’ve mentioned that the stock market is well-known to be volatile, and an example of this is happening right now - as the uncertainty surrounding the new Coronavirus impacts the economy.

The week commencing February 24th 2020 was the worst for US and UK stock markets since the financial recession of 2007/08, with losses associated with Coronavirus surpassing £3.8 trillion in a single week.

The virus has caused concerns regarding the global supply chain, as many factories and businesses in China - where the virus originated - have been temporarily shut down. 

For example, the main factory in China for assembling iPhones has been closed due to the spread of Coronavirus, causing Apple’s share price to be hard-hit, because of a slow-down in the manufacturing (and therefore selling) of iPhones.

Though the Dow Jones Industrial Average in New York bounced back on Monday March 2nd, surging 5.1%, and the FTSE 100 in London climbed more than 2%, the sharp drops highlight the market volatility. This is especially noticeable when considering that in the weeks before the Coronavirus-related slumps, the Dow Jones Industrial Average hit a record high. 


Choosing the right investment product for you

When deciding whether an investment product is for you, understanding their risks and returns will hopefully get you on the right track.

Both the IFISA and the Stocks and Shares ISA have a mid/high risk profile, and returns are not guaranteed with either. But both accounts also have their advantages - such as inflation-beating target returns - that experienced investors in particular may consider to be worth the risk.

One of the most powerful things about ISAs - other than their tax efficiency - is that you can have more than one. If you’re happy with the features of both an IFISA and a Stocks and Shares ISA, you could open and subscribe funds into one of each (as long as you don’t exceed your annual ISA allowance). 

Investing via both accounts can help in minimising risk, as you’re not over-exposing yourself to one kind of asset, and falls in the value of one investment will not affect your whole portfolio.


The Innovative Finance ISA Guide

The CARLTON Bonds product is available exclusively to experienced investors who are classified as either sophisticated investors, high-net-worth individuals or professional investors and have the knowledge and experience to make their own investment decisions. Investments are high risk and illiquid, your capital is at risk and returns are not guaranteed. Bonds are not protected by the Financial Services Compensation Scheme (FSCS).


Originally published 3rd March 2020, updated 26th May 2020.