Is an ISA still a good option for investors in a volatile market?

We're in the middle of the worst global pandemic in living memory, meaning people are naturally worried about the health and wellbeing of their loved ones. Though this is currently at the top of the agenda, many people will also be considering how to maintain the health of their investments.

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In the current climate, it's not easy to maximise the value of spare cash. The COVID-19 outbreak has sent stock markets into a tailspin, decreasing the value of equity investments, and interest rate cuts have diminished potential returns on lower-risk investments.

Millions of people's pensions have been hit by falling asset prices, and firms have found it even harder to access finance. Surging bond yields have made it more expensive to fund spending plans and governments are reliant on central banks for the liquidity needed to pay out against their commitments - which include multi-billion-pound financial support packages to protect companies and jobs.

All of the above will have investors wondering where to invest their cash in this new tax year, and with the tax-efficiency of the ISA - as well as the fact that the annual ISA allowance has reset to £20,000 for 2020/21 -  many investors may choose to add an ISA(s) to their investment portfolio. But what types of ISA products are available?


Cash ISA

A Cash ISA is a type of savings account that allows investors to save money tax free, meaning they are able to keep all of the interest earned (as long as their deposits don't exceed the annual ISA allowance, which is £20,000 this tax year). 

Cash ISAs are offered by UK regulated banks and building societies, and they're protected in the event of provider failure. 

There are also a few different types of Cash ISA;

  • instant-access (or easy-access)
  • fixed term
  • flexible

The key disadvantage of a Cash ISA are the typical interest rates on offer. In the current low interest economy - where the Bank of England recently lowered the base rate to just 0.1% - the highest returns on offer are about 1.5% for a three-year fixed term Cash ISA, and 1.25% for an easy-access Cash ISA.

Despite these modest returns, this type of investment may be attractive to investors who want to shield cash reserves until stock markets become less volatile.


Stocks and Shares ISA

The stock market tends to rise in value over time, making it an attractive investment opportunity for investors who are in it for the long haul. 

However, investors who are looking for a shorter-term investment may find that sudden, unexpected events that cause dramatic fluctuations in stock prices can mean they lose as much as they had hoped to make. This has been seen over recent weeks as the COVID-19 crisis took hold. As factories and offices temporarily shut down due to the effects of the virus, a huge fall in markets around the world was triggered. 

This volatility means that there is no guaranteed return on this type of investment, although potentially there is a lot of money to be made if the investment is well timed.


Innovative Finance ISA (IFISA)

The Innovative Finance ISA (IFISA) falls into the alternative investment category - unlike the Cash ISA and Stocks and Shares ISA, which are generally viewed as traditional investments. 

Against the current backdrop of low interest rates, experienced investors and higher earners are paying more attention to investment opportunities that have no correlation to the fluctuations of the stock market. 

Read more: download the Innovative Finance ISA guide

The IFISA was initially introduced to allow investors to become involved in the growing alternative finance market, while being able to invest under the ISA tax wrapper - and they have proven popular. 

IFISAs allow investors to hold peer-to-peer (P2P) loans and debt-based securities under the generous ISA tax wrapper.

A P2P loan is a loan made from an individual lender to consumers, and more recently, SMEs. P2P loans offer better rates for borrowers than are offered through traditional financing from banks, and better returns for lenders with target interest rates upwards of 6%. A debt-based security (or mini bond) is an asset-backed investment opportunity, taking in residential property developments and green energy projects and providing typical returns of 4-8%.

With an IFISA, investors will typically be required to tie up their funds for a fixed term - usually between two and four years. 

The overall risk of IFISAs comes down to the underlying asset - business, consumer, property or green energy.

Read more: what assets are IFISA eligible? 

Some investments will be secured against the asset - adding an additional peace of mind for the investor - but this doesn't free the investment from risk entirely and in the event of an economic downturn, you may not get back the amount invested. 

The term impact investing means that the investment not only has the potential to deliver financial returns, but also creates a positive social, economic or environmental benefit. The IFISA - and it's variety of eligible assets - has the ability to do this.

This is a powerful lure in an age where social conscience and responsibility are high on the agenda. Although economic activity has temporarily slowed due to the COVID-19 pandemic, clean energy projects will still be prioritised and affordable homes will still need to be built to address a chronic shortage. 


Which investment is the best in an economic downturn?

No single investment will beat an economic downturn, and the right investment for any investor will be depend on a number of factors;

  • risk tolerance
  • financial goals
  • life circumstances

The more important thing right now is to try and recover from the impact of COVID-19. A collective effort is required to help the economy bounce back - for example, by ensuring businesses have access to finance and house building schemes are fast-tracked from planning to development stage. This, in turn, will stimulate the investment market and give a much-needed confidence boost to investors who will be seeking to build balanced portfolios to spread risk across different asset classes.

It's crucial that investors don't underestimate the ISA, as they're an increasingly important part of the investment portfolio mix. 

The Cash ISA offers a safe haven for cash in a volatile economic environment, while the Stocks and Shares ISA can be an decent long-term investment option. 

Then there's the IFISA, which supports the growing alternative finance sector - a sector that has grown into a mainstream market in the years following the 2008 financial crash, which made it more difficult for individuals and businesses to get affordable finance from mainstream banks - while offering attractive target returns.

As the global economy tries to recover from the devastating impact of COVID-19, alternative finance will become even more important, providing much-needed capital for businesses and projects that can drive economic growth.    

The combination of tax free returns and the opportunity to hold different types of ISAs means that investors will have plenty of options when considering how to weight their £20,000 ISA allowance in this new tax year. For many, ISAs will continue to be an important way to save and invest as they try to navigate their way through stormy economic seas.

Read more: preparing for the new tax year: how many ISAs can you have?


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).