Is an IFISA a suitable first ISA product for an investor?

The Innovative Finance ISA’s (IFISA) generous, tax-free potential returns and opportunities to invest for impact make it an attractive investment consideration.

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Alongside the fact most IFISA-eligible assets are also uncorrelated to the Bank of England’s base rate – which caused interest rates on most savings accounts, including the Cash ISA, to plummet when it dropped to 0.1% in March 2020 – and the fluctuations of the stock market, its rapid growth since it was introduced in April 2016 is unsurprising. 

But that doesn’t make it a suitable ISA option for all investors. For first-time investors or those with limited experience – known as everyday investors – there could be more appropriate ISA products to begin with. 

However, for experienced investors – those classified as sophisticated, professional or high-net-worth – willing and able to take higher risks in order to maximise target returns, the IFISA could be an important addition to their ISA portfolio.

Whilst it’s crucial to seek independent advice before making investment decisions, understanding the following will help when considering whether an IFISA is an appropriate investment option for you. 


Understanding the risk profile of an IFISA

All investments have risks. Whether investing into the stock market via a Stocks and Shares ISA, or backing startups through venture capital, investors must be aware that the value of their investments can decrease as well as increase, and returns can never be guaranteed. 

This is also true when investing via an IFISA. Considered a medium–high risk product, the IFISA allows investors to hold peer-to-peer loans and debt-based securities under the popular ISA tax wrapper. 

The alternative assets that can be held in an IFISA – such as fixed-term, asset-backed property bonds – often offer higher potential returns than some mainstream investment products, but with these come higher risks, too. 

The exact risks associated with an IFISA depend on multiple factors. This includes whether the investment is secured on assets of the borrowers, offering some downside protection, and whether the IFISA provider has a successful track record with the relevant expertise to be offering the product.  

As the Financial Conduct Authority (FCA) has found a high number of consumers investing into high risk investments which are not appropriate for their needs or risk appetite, promotional rules for the likes of peer-to-peer lending have been tightened. Due to this – as well as the medium–high risk profile associated with most IFISA-eligible assets – the IFISA is considered most suitable for experienced investors.


Adding an IFISA to your ISA portfolio as an experienced investor

Though unsuitable for most first-time investors, for experienced investors looking to put their £20,000 annual ISA allowance to work, the IFISA’s potential returns of between 4% and 8% make it an important investment consideration. 

As experienced investors will be aware, in the search for higher returns, higher risks should be expected. And those with the appropriate appetite for risk could benefit from more than just the attractive, tax-free returns targeted by the IFISA – as the product also boasts opportunities to invest into impact-driven investments.

Due to the product’s wide range of eligible assets, investors can use an IFISA to support environmental projects such as the provision of wind farms at a time when the climate crisis is at the forefront of global attention, or to help tackle the UK’s ongoing housing shortage by providing small and medium-sized housebuilders with much-needed access to alternative finance.

And this is all while targeting returns that are shielded by the ISA tax wrapper. This becomes even more advantageous when considering that, in order to earn returns in the region of 7.75% (common target rates with some property-backed IFISAs) outside of the tax-free banner, the equivalent rate of return required would be circa 14% for additional-rate taxpayers. 

Whilst cautious savers or first-time investors could find other ISA products such as the Cash ISA more in-keeping with their risk appetite, some experienced investors will be disillusioned with rock-bottom interest rates and the volatile nature of the stock market – and for these, the addition of an IFISA to their ISA portfolio has the potential to prove lucrative.


Deciding which is the right ISA for you

It’s advisable to seek independent financial advice when making investment decisions, but having a clear understanding of what each ISA has to offer and who they are most suitable for is a crucial place to start when looking to build an ISA portfolio.

As most IFISA-eligible assets are targeted to experienced investors due to their medium–high risk profiles, it is unlikely to be an appropriate ISA option for new investors – but with four main Adult ISAs now on the market, there are other choices for those looking to maximise returns with an ISA’s tax-free status. 

But for experienced investors – who are comfortable with the associated risks – looking to target high returns whilst investing for impact, the IFISA is well worth exploring.