Understanding cash ISAs: What you need to know

2 minute read

Cash ISAs have long been a popular choice for savers in the UK, but recent trends indicate that they may no longer offer the best returns. With inflation on the rise and interest rates dropping, it's essential to understand how these accounts work and consider alternative options for your savings.

1. Mind the inflation gap

As of January 2025, the Consumer Price Index (CPI) inflation rate hit 3%, while the average interest rate on cash ISAs, including bonuses, stands at just 1.77%. This means that in real terms, cash ISA savers are facing a loss of 1.23%. This situation has led to speculation about potential changes to the tax benefits associated with cash ISAs.

2. Why cash ISAs are losing appeal

Although there was a brief period where cash ISAs delivered returns above inflation, January 2025 marked the third consecutive month of real-term losses. For example, back in July 2022, savers experienced a historic 9.4% loss due to inflation outpacing the returns on their savings.

3. Considering alternatives

Savers should consider stocks and shares ISAs if they can afford to lock away their money for a few years. Historically, these accounts have a better chance of keeping pace with inflation. For instance, a £10,000 investment in a cash ISA in December 2012 would now be worth £11,955, but adjusting for inflation, this is just £7,918. In contrast, the same amount invested in the IA Global Equity index would be worth £33,526, or £22,221 after inflation.

4. Top tips for savers

If you're considering diversifying your savings strategy, here are some top tips to keep in mind:

Understand your investments: Always know what you're buying, including the return drivers and associated risks.
Have a realistic plan: Know how much you can set aside each month and understand your capacity for loss. Investing is a long-term strategy.
Diversify, diversify, diversify: Spread your investments across various asset classes to reduce risk. This can include shares, bonds, property, and alternatives.

Beware of social media advice: Be cautious of unregulated advice on social media. Stick to financial advice from regulated professionals.
Watch out for scams: Be wary of investment propositions that offer unrealistically high returns, downplay risks, or pressure you to make quick decisions. Always check the FCA’s register to ensure you are dealing with a regulated firm. For more information visit https://www.fca.org.uk/scamsmart.

5. Conclusion

While cash ISAs can still be a part of your savings strategy, especially for short-term goals, it's essential to be aware of their limitations in the current economic climate. By diversifying your investments and considering alternatives, you can better protect your savings from inflation and potentially achieve better returns over the long term.

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