Q

What's the difference between a cash and stocks and shares ISA?

A

One is better for the short term, and the other for the long term.

The fact that you’ve arrived here suggests that you’re familiar with ISAs, the best way to avoid paying HMRC without having to spend time in prison.

ISAs — short for Individual Savings Accounts — allow Britons to put away a big chunk of money every year without having to pay any tax on its interest or gains. How big a chunk? Currently £20,000 big, meaning a lifetime of annual investments might yield hundreds of thousands in tax-free gains. There are two primary kinds of ISAs. There’s the plain-jane vanilla cash ISA, which is the kind of ISA your local bank branch offers. In the very short term, they’re useful places to park your money in case you need it right away. The good news about cash ISAs is there’s little risk of losing any money — the FSCS insures cash ISAs up to £85,000 in case of bank failure. But the bad news is that the average interest rate banks offer is currently less than 1% annually.

If you’re a long-term investor — that is, you plan to hold onto the money for at least five years — it would be insane to keep your money in a cash ISA, since the interest won’t even keep pace with inflation, meaning that over the long term your money will actually be worth less than when you deposited it. You’ll instead want a stocks and shares ISA, which in the short term will be more volatile than a cash ISA, but will offer the opportunity for high returns in the long term.

What you put in your stock and shares ISAs is entirely up to you. Think of it as a financial shopping cart into which you might toss a company’s individual shares, unit trusts, open-ended investment companies (OEICs), bonds, or a combination of all of them. Wealthsimple humbly suggests another option — that you consider a diversified portfolio of ETFs, or exchange trades funds, which are bundles of stocks or bonds that mirror the performance of the overall market and boast very low management fees. Over the long term, these so-called passive investments have a history of outperforming the more expensive actively traded unit trusts.

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