Stocks and shares ISA or cash ISA – which is best for me?

So, you want to take advantage of the tax-free savings potential of an Individual Savings Account (ISA). But how do you decide whether a cash ISA or a stocks and shares ISA is best for you?

For years, the interest rates offered on cash ISAs were very low. But the steep rise in interest rates since the end of 2021 has made the rates for cash ISAs a lot more attractive. Currently, according to moneysupermarket.com some fixed-rate cash ISAs are offering between 4.05% and 4.76% on terms between one to five years*. That’s a better rate than was previously offered. But, if you only hold a cash ISA, you could put a rather low ceiling on your potential gains.

Read on to delve into the differences between cash ISAs and stocks and shares ISAs and learn more to help you decide which is best for you.

*As at 30 May 2024

How do they differ?

A cash ISA is much like a traditional savings account, with interest paid on your savings. But the difference is that you won’t pay tax on any interest you earn with an ISA.

A stocks and shares ISA – as it says on the tin – allows you to invest your money in the stockmarket. You save paying tax here as well, as you won’t pay capital gains or income tax on any gains you make or dividends you receive. However, the rate of return you receive will vary, depending on how the investments in your ISA perform, as the value of your investment can go down as well as up, so you might not get back the amount you put in.

When it comes to investing in the stockmarket, you should consider investing for the long term (with five years, ten years or even longer in mind). The longer you invest, the more time your investment has to even out any peaks and troughs along the way.

With either type of ISA, there’s a £20,000 ISA allowance this tax year (from 6 April 2024 to 5 April 2025). You can hold multiple ISAs, but your total allowance for this tax year remains at £20,000 for all the ISAs you hold.

Which is best for me?

If you choose a cash ISA, your gains will be capped at the interest rate offered when you open the account. If you go for a ‘fixed-rate’ cash ISA, then your money will be locked away until the fixed-rate term ends. If you go for an ‘instant access’ cash ISA, you will have access to your money, but these accounts usually pay less in interest.

If you opt for a fixed-rate ISA, you can transfer your money out of the account once the specified period ends. If you then choose to reinvest in another cash ISA, available rates may have fallen depending on the prevailing economic environment, meaning your savings will earn less.

That said, if you’re only looking to invest your money for a short period of time (one to five years), cash ISAs may be the best option for you.

If you’re interested in long-term growth, you may be more suited to a stocks and shares ISA where your savings have the potential to rise significantly – depending on the stocks and shares you invest in. Your earnings aren’t capped, which offers the potential for greater rewards, but there’s also the risk that the value of your investments could go down and you could lose money.

And if I don’t want to choose?

That’s a completely viable option! You may want to take a ‘mix and match’ approach, and diversify your wealth by spreading your allowance between both a cash and a stocks and shares ISA.

If you choose this approach, potential gains or losses from a stocks and shares ISA will be smaller (as less money is invested in the stock market). You’ll have fewer ups and downs from the cash ISA, so if you prefer a little more security, dividing your ISA allowance between both types may be the strategy for you.

Please note, The M&G ISA is a stocks and shares ISA only.

Please remember that the tax rules for ISAs can change at any time and will depend on your individual circumstances.

The views expressed here should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.