Go Passive To Boost ISA Returns

Individual Savings Accounts are getting a bad rap this week. Report after report has emerged, illustrating how fees have been eroding savers’ returns and how cash ISAs have lost value in real terms over time.

But investors should not be deterred from saving or investing: it’s about knowing where and how to invest. In fact, if investors had placed their cash in a medium risk passive portfolio within a stocks and shares ISA with a low cost provider, it could have been a winning bet.

First, let’s take a look at the new research on cash ISAs. Unless you had opened your account in 1999 or 2000, you would have lost money in real terms over the last 13 years when you factor in interest rates and inflation, according to online fund manager Nutmeg. Nutmeg’s research found that UK inflation, as measured by the Consumer Prices Index, fell under 2 percent for the first time since November 2009, but the average interest rate on a cash ISA is only 1.17 percent.

Nutmeg chief investment officer Shaun Port compared that to putting the same amount into a medium-risk portfolio of stocks and shares every year since 1999.

He said: “Your money would have gained in value every year but one [2013], and would have done better than the cash ISA or each of the last 15 years, bar none - again, that’s in today’s money, after accounting for inflation.”

This study used monthly Bank of England data for cash ISAs’ value, and the passive portfolio is based on 60 percent invested in the MSCI UK Net Total Return Index (UK stocks) and 40 percent in the BoA Merrill Lynch UK Gilts Total Return Index (UK bonds), less costs of 1 percent per annum.

Nutmeg’s medium risk portfolio number six gave a 14.5 percent return last year, after fees. The average competitor offers 8.8 percent after fees, according to monthly data compiled by consultancy firm Asset Risk Consultants (ARC). Nutmeg’s higher growth portfolio number seven returned 16.3 percent last year, compared to the average competitor’s 12.5 percent.

But stocks and shares ISAs, and good underlying performance, have not escaped criticism this week. New research from mutual fund company Vanguard has revealed that investors could have lost out on nearly £10,000 in fees over the long term.

Based on an assumed real return of 4.5 percent over 30 years, an investor paying an ongoing charge of 0.5 percent for a stocks and shares ISA would have ratcheted up £38,171 in savings, while an investor paying 1.5 percent per year would have only saved £28,303. This assumes both investors use their full annual allowance.

Nick Blake, head of UK retail at Vanguard, said that costs should always be at the forefront of investors’ minds.

“It can be tempting during ISA season to look at what’s been performing well and invest your ISA allowance into it without further thought,” he said.

Investors are encouraged to use up the full yearly allowance into an ISA, which is £11,520, and allow investments to accumulate. The tax advantages are high – no capital gains tax on profits and only 10 percent tax on dividends. Furthermore, Einstein’s “eighth wonder of the world” – compound returns – can make your capital soar.

Whether it’s a stocks and shares ISA, a cash ISA, or a direct portfolio of passive funds, do not be deterred from saving and investing.