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Compares Cash-ISAs and Stocks-and-Shares-ISAs

For tax-year from April 2017 we can put up to £20,000 per year into tax-free savings whether Cash-ISA or Stock-and-Shares-ISA or a combination of the two. With average annual gross earnings around £27,000; the £20,000 limit is more than enough for the ordinary saver.

Cash ISAs

Cash-ISAs are risk-free. From 1st January 2016 the government guarantee reduced to £75,000 per provider.
Between 2010 and 2014 savings were being slightly eroded by inflation.

On 04.08.2016 Bank of England reduced its base rate from 0.5% to 0.25%, a record low. So Banks/building societies reduced their savings rates.
Savings are again being eroded by inflation.
£10,000 in a savings account returning 2.0% less than inflation loses £200.00 per year in purchasing value.

BOE base rate

Review your accounts occasionally to ensure you continue to receive a competitive rate. Visit a price comparison website such as comparethemarket for current rates.

From April 2016 savings interest in regular savings accounts is paid gross and basic-rate taxpayers can receive interest of up to £1,000/year tax-free: the new personal savings allowance. £1,000 would be £40,000 at 2.5%. So Cash-ISAs are no longer the only tax-free choice.
The Martin Lewis MoneySavingExpert website has good description of savings account options.

According to HM Revenue & Customs data Cash-ISAs are more popular than Stocks-and-Shares-ISAs, in the tax-year to April 2017 80% of all ISA accounts were Cash-ISAs, the highest proportion since 2008.
Prospect of several years of low savings rates and higher inflation should point us towards Stocks-and-Shares-ISAs.

Stocks and Shares ISAs - Index Tracker Funds

Stocks-and-Shares-ISAs are NOT risk-free.
FTSE-100 was 6930 at end-December 1999, and had fallen to 3287 in mid-March 2003. It was about 6730 on mid-June and mid-October 2007 and had fallen to 3512 early-March 2009. It was back around 7000 during the first 6 months of 2015 and again during the final months of 2016.

These huge variations make me cautious of equity-based savings, but ignoring equities removes the possibility of higher returns.

The theory is that low returns go with low risk, and higher returns with higher risks; and in the long-term equities will out-perform savings accounts.

Risk Matrix

Period 1990-1999 was exceptionally good for equities; 2000-2009 was bad for equities, we lost money in real-terms and we would have been better-off investing in Cash-ISAs; period 2010-2016 was better for equities. This is illustrated by the table showing outcomes for £10,000 invested at the start of the period. As with all examples start and end dates matter, 2000-2009 included two stock-market crashes.

1990-199910 years£13,619£19,600£37,535
2000-200910 years£12,139£15,453£10,910
2010-20167 years£11,581£11,511£17,120

Sticking with the UK stock-market reduces currency risks. Using index-tracker funds spreads risk across many shares. ISAs based on index-tracker funds should have no initial charge (sometimes 5% for other funds) and annual charges which are lower than those for actively-managed funds. They can be bought over the web and are easy to understand.
There is research from US universities which says trackers overall, on-average, out-perform actively-managed funds.
Trackers account for only 10% of funds invested each year by retail investors; so not everyone shares these opinions.

Advantages of index-trackers are recognised by Warren Buffett.Show Buffett on Trackers

Warren Buffett on Index-Trackers

Warren Buffett

Whilst not part of his own investment methods

"risk comes from not knowing what you are doing"

"diversification is a protection against ignorance; it makes very little sense to those who know what they are doing."

Warren Buffett does recognise the advantages of index-trackers:

Advises his wife to invest her inheritance in index-trackers after he dies

March 2014 - widely reported

As part of the 49th Berkshire Hathaway annual report that came out earlier this month, Warren Buffett wrote that he has given instructions to his wife/long-time partner Astrid Menks on what she should do with the money she inherits when he dies.
One might think that the instruction might get quite complicated since she'll be inheriting money from one of the richest men in the world.
The truth is the advice is quite simple.
Warren Buffett wants his partner to invest 90% of her inheritance into a low-cost S&P 500 index tracker. He also advised that she should invest the remaining 10% into short-term government bonds. That's it. Nothing fancy.

And his advice has been consistent:


"By periodically investing in an index fund, the know nothing investor can actually out perform most investment professionals. Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb."


"Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."


"A very low cost index is going to beat a majority of the amateur managed money or professionally managed money. The gross performance [of a hedge fund] may be reasonably decent, but the fees will eat up a significant percentage of the returns. You'll pay lots of fees to people who do well, and lots of fees to people who do not do so well."

Bet $1million that index-tracker fund will outperform hedge-funds over 10-years

reported in Daily Telegraph 04 February 2015, by Richard Evans

The cheap tracker funds that anyone can buy will make you more money than hedge funds available only to the seriously wealthy, according to Warren Buffett.
And the world's most famous investor has put his money where his mouth is.
In 2008 he entered into a bet with an American asset management firm that the main US stock market index, the S&P 500, would outperform a group of five hedge funds over a 10-year period.
The results of the seventh year of the bet have just been announced - and Mr Buffett, and the humble index tracking fund, are decisively in the lead.
In 2014 the S&P 500 tracker fund chosen to represent the index in the bet rose by 13.6pc. The average gain for the hedge funds was just 5.6pc, according to Fortune magazine, which has been monitoring the bet annually.
Since the bet was taken out, the index fund has risen by 63.5pc. The hedge funds, which were picked by Protege Partners, a New York money manager, are up by about 20pc (the exact figure is not known because not all the hedge funds have yet reported their figures).
The tracker has beaten the hedge funds in each of the past six years. Only in the first year of the bet did the hedge funds 'win', falling by 24pc amid the turmoil of the financial crisis against 37pc for the tracker.
Whoever loses the bet at the end of the 10 years has to pay at least $1m to a charity chosen by the winner.
Even the hedge fund champions now concede that Mr Buffett is likely to win the wager, saying that only a severe fall in the stock market could see the hedge funds back in the running.

This website focuses on FTSE All-Share index-trackers.
Should you have the inclination, time and money, check out the Morningstar website and its OEIC/Unit Trusts, Fund Performance pages.
It is free, topical and reliable but takes a bit of getting used to.

Defined Contribution Pensions

We now own our own pensions. George Osborne's 2014 budget removed many restrictions on pension-pot withdrawls for people retiring after April 2015.
A year after the reform, most large fund providers are offering a direct-to-consumer flexi-access drawdown product. Whereas before the reform investors with less than £100,000 were not considered suitable for drawdown and had to buy an annuity.
The reform is not going to improve long-term bond yields.
Withdrawls are taxed at your marginal income-tax rate.

Employer contributions and the tax advantages of pensions make them an attractive savings option. Pension contributions are free of tax but not national-insurance and a 25% tax-free lump-sum can be taken when the pension is cashed-in.
Pay the tax and buy an ISA is a possible choice for saving earlier in a working lifetime when money locked in a pension may be seen as too inflexible.

Prospect of Lifetime ISA

If you already receive maximum employer pension contribution and you are under 40, George Osborne's 2016 budget announcing Lifetime ISA's is of interest.
From April 2017, people 18-to-40 can start an ISA account, investing up to £4,000/year and receiving 25% from government, max £1,000/year, at the end-of-each tax-year. 25% rebate continues up to age 50.

Last updated 22 April 2017.