Innovative Finance ISAs Set to Take Off in 2018
Ever since interest rates were slashed to avoid a depression in the wake of the 2008 financial crisis, savers have suffered from wafer thin returns on cash ISAs. Last year was the worst on record, with average returns at an historic low of 0.93 per cent, according to Moneyfacts.
Now that interest rates are heading upwards, cash ISA rates will surely improve, won’t they?
Unfortunately, that doesn’t seem likely. For a start, with growth remaining sluggish, a big rise in base rates from the current level of 0.5% is not on the cards. There are also technical obstacles in the savings market to higher returns on cash ISAs. One significant factor is the introduction of the personal savings allowance, which lets basic rate taxpayers receive their first £1000 in interest income free of tax. Higher rate taxpayers have a lower allowance of £500.
With interest rates on some taxable savings accounts already exceeding those on cash ISAs, the tax break has become less attractive. Right now, savers who pay basic rate tax can put £100,000 in a taxable account offering 1 per cent interest and will not have to pay any tax. Let’s face it, how many basic rate taxpayers have that amount of spare cash to put aside? Most will have a lot less, so why would they bother with a cash ISA when taxable accounts offer them equivalent or better tax free returns?
Another factor weighing on returns from cash ISAs has been the availability of cheap money for banks from the government through the Funding for Lending Scheme. Designed to encourage financial institutions to pass on the benefits of ultra low interest rates to borrowers rather than hoarding cash to bolster their balance sheets, the scheme has had the side effect of weakening the incentive to offer competitive savings rates in order to attract money from savers.
Given all the drawbacks of cash ISAs, it is not surprising that some savers have become stock market investors instead. However, for those who prefer a bit more security, they might like to consider an Innovative Finance ISA (IF ISA), which tends to offer higher rates of return than a cash ISA but with less volatility than a Stocks and Shares ISA.
Launched by the government in April 2016 to reflect the growing popularity of alternative finance platforms, IF ISAs have been slow to take off but are likely to gain more attention this year as more alternative finance platforms enter the market. In the past 12 months, the largest three have now been authorised by the UK regulator and are likely to begin promoting their offerings soon, resulting in a lot more visibility. With plenty of choice for investors, an uptick in inflation, and £600bn lounging in cash ISAs, the 2018 opportunity for IF ISAs is enormous.
“2018 is going to be the biggest year yet for the IFISA,” says Andy Davis, a former Financial Times journalist who has conducted research into the market for AltFi, the alternative finance news site. “There is massive ignorance out there about the IFISA … There’s a hell of a lot of education still to go.”
IF ISAs may offer attractive returns but they are not risk-free. Unlike the majority of FCA-authorised bank and building society savings accounts and Cash ISA accounts, the returns from Innovative Finance ISA (and Peer-to-Peer lending activities generally) are not protected by the Financial Services Compensation Scheme. However, while they may feel safer, cash savings accounts are not entirely risk free either. With inflation at 3%, and average interest rates on cash ISAs below 1%, real returns are negative. Savers are effectively paying banks to look after their money. Instead of receiving what they perceive as a risk-free return, what savers are actually getting is return-free risk, the risk being that of a steady reduction in the purchasing power of their hard earned savings.
By contrast, while IF ISAs can, in a worst-case scenario, mean a permanent loss of capital, managed carefully and professionally, they can deliver attractive returns that far outweigh those available in cash ISAs. Bond investments on Property Crowd are ISA eligible and deals which have gone full cycle and been redeemed have on average returned 12.77%. And, as anyone who has checked the balance in their stocks and shares ISAs since the recent big sell-off can testify, it will have delivered a much smoother return profile.