Impact of cash ISA rates on retail investing

One factor behind challenging fund sales through 2023 is the increased appeal of cash savings as higher interest rates filtered through to savings products. In 2023, Bank of England data show inflows to cash ISAs totalling £47.2 billion, higher than the inflows of the previous eight years combined and beating 2001 the previous record year, which attracted inflows of £28 billion.

Following the cycle of Bank of England interest rate rises starting at the end of 2021, the interest received on cash savings has steadily increased. Fixed rates for new cash ISA customers peaked at 5.35% in October 2023 but have since fallen to 4.35% in March 2024 (the latest BoE data). The opposite chart shows net movements of assets to cash ISAs, illustrating the scale of the flows in 2023. This has continued into 2024 with a further £9.1 billion inflow to cash ISAs in the first quarter. While outflows from funds and inflows into cash ISAs are not necessarily the same money, the higher flows to ISAs are indicative of the increased appeal of cash.

Alongside higher rates than have been available in recent history, cash savings also offer a greater certainty of return, which may be especially important to investors uncertain over their own near term financial outlook, or facing concerns over a possible recession.

Using Bank of England and Morningstar data, we investigated how investors would have fared if they had placed £1,000 into a fixed rate cash ISA in 2023 or if they had invested the £1,000. Whilst one year is far shorter than the minimum recommended holding period for most funds of five years, it helps us to understand the experience for savers and investors through 2023.

Chart 3 shows that a saver putting £1000 into a new cash ISA on the 1st of January 2023 would have a balance of £1045 by the 31st of December. If the saver had remained in the same cash ISA that they had used the previous year, on average they would have added £26 over 2023. This compares with £127 if they had invested in a global equity fund and £69 in a balanced portfolio of stocks and bonds. They would have received a return of £74 if they had invested the £1000 in a typical UK equity fund.

But the January to December window was particularly kind to investors in funds. Chart 3 illustrates the volatility of returns that investors experienced compared with the steady and predictable returns on cash ISAs. For nine out of the 14 months we analysed, the average fixed ISA rate for new customers would have given a better return over the previous year than a global equity fund.

Investing brings the risk of loss and volatility of returns can foster a view that investing is riskier than keeping assets in cash. Investment fund returns also have to be higher than 5% to convince savers that the rewards of investing are worth the risk compared with cash: this was not the case in a low interest rate environment. This reinforces the importance of communicating to investors that investing must be over the long-term. Investing over five years or more helps to smooth out the volatility of returns as well as providing superior returns on cash.

Many investors fully grasp the importance of long-term investment horizons. When we asked 1000 investors about their primary motivation for investing in a stocks and shares ISA, a healthy 50% said that it was because they believed that investing would deliver them a better return than cash over 5 years and 77% agreed that they take a long-term view of investing irrespective of the rise and fall of markets. However, there were differences in the data. 62% of seasoned investors with 10 years or more experience used a stocks and shares ISA because they believed that investing would beat cash over 5 years. For new investors with one year’s experience or less this fell to 38%. Just 29% of 18-34 year olds chose investing beating cash as a major motivation for using a stocks and shares ISA compared with 61% of over 55s. Younger or inexperienced investors may be less prepared to experience short-term investment volatility if they can get a decent, stable return on cash.