February 14th, 2018

The UK’s number one finance blind spot?

By Andrew Craig

Reading time: ~ 5 minutes

Last week I was reminded of something I have run into time and time again since I set up Plain English Finance seven years ago:

The fact that so many people in the UK do not understand the difference between a CASH ISA and a STOCKS AND SHARES ISA...

This may well be the UK’s number one finance blind spot – which, I would argue, has had disastrous consequences for literally millions of people.

To explain: Last week I was having a debate with some folk on an investment-focussed Facebook group. I was making the case for ISAs and someone said something along the lines of: “You’re an idiot. I’m not investing in some useless 1% ISA. ISAs are rubbish.”

I have literally lost count of how many times I have heard this argument from someone who conflates the word “ISA” with the idea of a “Cash ISA” and is not even aware of what a stocks and shares ISA is or what it can do for them. This is such a huge failing of our education system and of the finance industry in general.

To explain a bit more: Back in 2012 I was looking for an editor for the first version of my book. Naming no names, I found a company who offered editorial services for a fee to people in my position from industry “experts”. I paid a reasonably chunky fee for an individual to review my manuscript who was “an expert on financial services” and who had apparently been a finance journalist at a number of leading newspapers and magazines over a thirty-year career.

Aside from telling me that my book was a good effort but would never see the light of day ( ;-) ), that individual certainly gave me some useful feedback but one of his comments set alarm bells clanging – essentially the same comment as the one above about ISAs.

Reacting to the section of my book which showed the amazing returns that compounding can create for an individual, my “editor” pointed out that in his copy of that week’s Sunday Times, the best ISA return he could see was about 2% (or whatever a Cash ISA was in 2012). I was flabbergasted. This long-time financial journalist, supposed finance “expert" and editor literally didn’t know what a stocks and shares ISA was.

I thought it might be instructive, therefore, to remind readers of the difference (and beg you to spread this information as far and wide as possible. If you have loved ones who have money in cash ISAs, please, please share this article with them. They are losing real wealth every year and will likely find it really hard to build any sort of wealth long term, all other things being equal).

A reminder of the difference

A cash ISA is not that different to a current account. You open an account and deposit cash. The only difference is that you get a slightly higher interest rate, depending on who you open the account with and you don’t have to pay tax on any interest you made (the main point of ISA accounts generally).

Anyone who has read my output for any length of time should know the main reason I would take a dim view of holding cash in your ISA account: With real inflation at the sort of level it is at today, you will most certainly be losing real wealth on any money you hold as cash. The interest rate you are likely to receive is lower than real inflation.

A stocks and shares ISA is a slight misnomer in that it simply enables you to invest any money held in that ISA account in a wide variety of assets (if you have an account with one of the better providers). That is to say that you can buy products such as funds, bonds and commodities, as well as just “stocks and shares”. In a “stocks and shares ISA” – you can choose to have up to £20,000 a year – or £40,000 for a married couple (at the time of writing) in any combination of cash or a huge range of investments, at your discretion.

It is shocking how many educated people are still unaware of the existence of stocks and shares ISAs, think that you can only ever achieve the pathetically low (loss making) returns offered by cash ISAs and who therefore ignore the ISA as a financial product altogether.

Such individuals have missed out on the opportunity to compound tens of thousands of pounds of their money each year whilst completely avoiding tax – a huge advantage that we are so lucky to have living in the UK. For some, this miss may have resulted in a seven-figure administrative failure. The fact that so many people fall into this category (including the first person I employed to edit this book back in 2012, as I say) is a massive black mark against the mainstream financial services industry and our education system.

If you are to have any chance of making a real return on your money and becoming wealthy over time, you need to invest in things that have a chance of outperforming inflation. There are many ways of doing this and a stocks and shares ISA is almost certainly the best vehicle available to you for this purpose as a UK citizen.

I would also remind readers that there are many ways of doing this without having to worry about whether there is a stock market crash or not. There is a great deal being written about the possibility of a big market correction or “crash” at present, particularly given many of the world’s stock markets fell 10% or so in early February.

I think it is worth reminding ourselves that crashes come and go reasonably quickly in the grand scheme of things and needn’t bother you that much if you’re investing regularly each month because you will be averaging in – especially if you’re doing so in a tax free vehicle like an ISA. If you look at many decades of evidence, financial markets spend a great deal more time trending up than crashing – largely because of scientific progress, economic development and population growth.

People have been worried about a stock market crash for several years – in which time many stock markets have doubled or even better than that. Sitting in cash for years worrying about a crash will very likely have been more detrimental to someone’s investment prospects than investing regularly, even through any coming crash.

Using a stocks and shares ISA and making regular monthly payments into something sensible has a high probability of building significant wealth over time. It is a real tragedy on so many levels that too few people understand this and are languishing in value destructive cash ISAs.