A beginner’s guide to stocks & shares ISAs - and how they are different to cash ISAs

The difference between stocks & shares ISAs and cash ISAs explained (Photo: Shutterstock)The difference between stocks & shares ISAs and cash ISAs explained (Photo: Shutterstock)
The difference between stocks & shares ISAs and cash ISAs explained (Photo: Shutterstock)

by Derin Clark

With savings rates continue to fall, some long-term savers have started considering stocks & shares ISAs as an alternative. Stocks & shares ISAs are often seen as attractive to investors as they have the potential to offer much greater returns on the investment compared to interest rates on standard savings accounts.

Saying this, the potential for greater returns also means greater risks, and investors should always be aware that stocks & shares investments carry the risk of not only achieving zero profits from money invested, but investors can also lose the initial lump sum deposited as well.

The good thing about stocks & shares ISAs is that you don’t have to be a finance expert to set one up or manage your investments, as there are now accessible platforms that will do this for you and many are designed for beginner investors – although these platforms do charge additional fees. As well as this, you don’t need tens of thousands of pounds to start investing, but instead you can set up a stocks & share ISA with a moderate amount of savings.

However, before considering investing in a stocks & shares ISA, it is important to have some financial knowledge and fully understand the risks involved in the investment.

Stocks & shares ISAs vs cash ISAs

A cash ISA is a savings account that has the benefit of allowing up to £20,000 in tax-free deposits during the 2020/21 tax year. Most ISAs you see being offered by your bank or building society will be a cash ISA.

Within cash ISAs, you get a number of different types of accounts, but the most common are easy access ISAs (which allow instant access to the money deposited), and fixed rate ISAs (which require the money deposited to be left untouched in the ISA for a predetermined period of time, for example five years). These ISAs will offer an interest rate, which is the money the bank will give you for depositing your money into their ISA, and savers can guarantee that they will receive both their initial deposit and the interest accumulated on the savings.

A stocks & shares ISA also allows £20,000 in tax-free deposits during the 2020/21 tax year, but these ISAs involve investing the money deposited into stocks and shares. This means that if the stocks and shares the money is invested in do well, they can achieve much higher returns than cash ISAs. But if the stocks and shares do not perform well, they can result in the investor losing all their money, including their initial deposit.

Normally, to try and safeguard investments as much as possible, investors will diversify the money invested by investing in a range of different types of stocks and shares. The idea behind this is that if one of the investments performs badly, there is money in other investments that will perform well.

Normally, a stocks & shares platform will encourage investors to diversify their investment by offering a wide range of different types of stocks and shares – you can find out more about investment platforms by reading the Moneyfacts.co.uk guide, UK investment platforms explained.

How risky is a stocks & shares ISA?

Investing in stocks & shares ISAs is risky and should not be considered by those who are risk-averse or who cannot afford to lose the money they invest. Saying this, you should be aware that even low-risk investments have the real risk that you could lose all your money.

Alternatively, speaking to a financial adviser before making any investments will help to determine your risk appetite and whether this is the right option for you.

Who should avoid stocks & shares ISAs?

Investing in a stocks & shares ISA should be considered as a long-term investment, with five years the minimum amount of time for leaving your money. This is because the stock markets tend to fluctuate, so one year your investments may perform badly, while the following year they can start to pick up again.

As such, investing in a stocks & shares ISA should be avoided by short-term savers. As well as this, the high risks involved with stocks & shares ISAs means that these are usually not the best option for those with little savings elsewhere.

Ideally, savers should have up to three to six months of their monthly income saved into an accessible savings account for emergencies and only after a substantial amount of savings are on hand should they consider stocks & shares ISAs.

Are stocks & shares ISAs just for the wealthy?

While it important to have savings deposited into other, safer, accounts, investing in stocks & shares ISAs is not just for the wealthy. It is true that you should be prepared to lose the money you invest, but investments using investment platforms can start from a small lump sum of a few hundred pounds and only require a small amount, for example £20 per month, to be deposited into the investments.

How do you set up a stocks & shares ISA?

Setting up a stocks & shares ISA through an investment platform is fairly easy and a list of platforms can be found on the Moneyfacts.co.uk Stocks & Shares ISA chart. Alternatively, investors can speak to a financial adviser who will be able to help you with your investments.

There is also the option of setting up your own stocks & shares ISA portfolio by investing directly yourself, but usually this should only be done by those with extensive financial knowledge and a thorough understanding of the stock market.

For more information about stocks & shares ISAs, visit Moneyfacts.co.uk