April 28, 2020
In the wake of the worst global pandemic in living memory, people are naturally concerned about their health and the welfare of their loved ones. Whilst this is top of the agenda, plenty of people will also be considering how to maintain the health of their investments.
Their best strategy is to build a diverse investment portfolio, which allows them to spread risk over several investments. These could be traditional investments such as equities or alternative finance options that don’t fall into conventional asset classes such as stocks, bonds and cash.
Many investors choose ISAs as part of their portfolio. ISAs are attractive due to their tax efficiency and the fact that the new ISA allowance for 2020-21 has been reset at £20,000. But what types of ISA products are available?
A cash ISA is a form of savings account that is offered by UK regulated banks and building societies. It’s a tax-free way of saving money, meaning that investors keep all of the interest that they earn, provided their deposits remain within the annual tax-free allowance (currently at £20,000 for the 2020/21 tax year).
The original investment is protected, and some providers offer a flexible facility that allows money to be withdrawn from the ISA, as long as this is done within the same tax year.
The big disadvantage of cash ISAs is the interest rates. In an ultra-low-interest economy – the Bank of England recently lowered the base rate to just 0.1 per cent – no cash ISA offers a great return on investment, with highest returns of about 1.5 per cent for a three-year fixed-term ISA and 1.25 per cent for an easy-access 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 ISAs
One of the primary benefits of this type of investment is that the stock market tends to rise in value over time. This means that investors in it for the long haul are likely to generate reasonable returns, especially if they invest in defensive stocks such as pharma and food companies which generally produce returns for shareholders over time. Some stocks provide income in the form of a dividend, although this is less likely when the economy is struggling as it is now.
However, investors looking for a quick buck may find they lose as much as they had hoped to make. Sudden, unexpected events can cause dramatic fluctuations in stock prices, as seen in recent weeks as the COVID-19 crisis took hold. This has triggered a huge fall in markets around the world as factories and offices temporarily shut down, although on occasions there have been sudden upturns, possibly due to investors putting their money into stocks in the hope of buying low and cashing in on a subsequent upswing.
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 (IFISAs)
While cash ISAs and stocks and shares ISAs are generally viewed as traditional investments, Innovative Finance ISAs (IFISAs) fall into the “alternative” category.
One of the reasons why IFISAs have proven to be so popular – and in fact, the reason why they were introduced initially – is that they allow investors to become involved in a growing alternative finance market, which was worth more than £6 billion in the UK in 2017. Being able to invest under the ISA tax wrapper makes it even more of an attractive proposition; that’s currently £20,000 (as of 2020/21) that can be invested and any returns realised tax-free.
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 per cent. 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 per cent.
Investors will usually be required to tie up their money in an IFISA for a fixed term, typically between two and four years. On some occasions these investments may even generate returns of more than 10 per cent.
The downside of this is that higher rates generally equate to higher risk. The overall risk of IFISAs comes down to the underlying asset: business, consumer, property or green energy. 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.