How is the ISA Market Faring Amidst Today’s Economic Backdrop?

By Jo Bentham22nd July 2022

As inflation reached a new four-decade hi​​gh of 9.4% in June – with the Bank of England (BoE) projecting it will continue to rise, hitting 11% by the end of 2022 – and the UK faces a cost of living crisis, the lingering effects of the Coronavirus pandemic and the impacts of the war in Ukraine, the ISA market has not gone untouched.

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Established over 20 years ago, the ISA has grown to be a household name, with 13 million subscriptions to an Adult ISA in 2019/20 alone according to the most recent statistics published by HMRC. 

But amidst today’s unprecedented economic backdrop, some ISA products have performed better than others. And with a generous, tax-free annual ISA allowance of £20,000, many investors can be questioning which ISA would be the best choice for housing their capital in the current climate.

 

Cash ISA savers have been hit by all-time low interest rates

Cash ISA savers saw interest rates tumble in March 2020 as Covid-19 struck and the BoE slashed their base rate to an all-time low 0.1%. 

The average Cash ISA rate on offer in 2020 was just 0.83%, and this went on to more than halve in 2021, when it hit a rock-bottom 0.38%. And whilst the BoE’s base rate has increased incrementally – now at 1.25% – Cash ISA rates are still far from keeping pace with rising inflation. 

The best instant-access Cash ISA on the market at the time of writing is 1.5%, and with inflation at an aforementioned four-decade high of 9.4%, it’s clear that cash savers risk the value of their capital eroding over the long-term, with its purchasing power diminished. 

With this mind, it’s unsurprising that the total accumulated holdings of Cash ISAs have decreased substantially for the first time since their inception, down from £295 billion in January 2021 to £289 billion in January 2022 according to the BoE. 

But having cash savings can be important, and for those planning on saving over their £1,000 Personal Savings Allowance (PSA) each year, the Cash ISAs tax-free wrapper does continue to make it a key consideration.

 

The Stocks and Shares ISA has been highly volatile

The Stocks and Shares ISA has long been a go-to for investors, with the potential for strong long-term capital growth and the added benefit of tax-free capital gains. 

And though investors should always expect fluctuations when investing into the equities market – with a five year minimum investment recommended in order to allow for falls in value to recover – the current macroeconomic pressures have led to unprecedented volatility. 

The average return gained on a Stocks and Shares ISA in 2018/19 was 4.04%, but in 2019/20, the year the Coronavirus pandemic hit and caused a market crash, it was -13.3%. 

As for 2022 so far, it has been another highly volatile and somewhat negative year for the stock market. The S&P 500, as an example, fell 20.6% in the first half of the year, its worst first-half performance since 1970. 

For long-time Stocks and Shares ISA investors, this won’t be too discouraging, as the long-term nature of the product means, for most, there is time for a recovery – with experts predicting a slower and more drawn out U-shaped recovery this time around, compared with 2020’s V-shaped climb. 

But it is more important than ever to ensure your ISA portfolio is well balanced and diversified, with a product able to withstand market turbulence and continue to target attractive returns over the short to medium-term.

 

The Innovative Finance ISA (IFISA) has proven somewhat resilient

New research from AssetTribe has found that demand for alternative investments is set to grow by up to 46% over the next 12 months in response to soaring inflation and a greater desire to diversify, and it’s here that the IFISA becomes a crucial consideration.

Opening the ISA wrapper up to alternative assets for the first time, IFISA-eligible assets include property bonds, which allow investors exposure to the UK’s ever-popular and resilient residential housing market, SME loans and green energy projects. 

The IFISA has gone from strength to strength since it was introduced in April 2016, with £438 million subscribed in 2019/20 according to HMRC data, a 33.5% increase on the previous year. 

And Peer2Peer Finance News have reported that many platforms received a record number of IFISA inflows in 2021/22, facilitated in part by a large number of ISA transfers from other ISA products as experienced investors alter the weighting of their ISA portfolios.

With target returns often in excess of 7%, separate research from Peer2Peer Finance News found the IFISA actually outperformed the stock market – namely the FTSE All-Share Index – over the four years from 2018 to 2021, and demonstrated more “stable” returns. 

 

An ISA could still play an important role within your wider portfolio

With its proven resilience and ability to target attractive returns, the IFISA has evidently fared somewhat better than both the Cash ISA and the Stocks and Shares ISA in today’s economic upheaval. 

But it’s when used in conjunction with one another that ISAs can prove a particularly beneficial addition to an experienced investor’s portfolio, allowing you to better withstand troublesome periods and work towards a number of investment goals and objectives.