However, with many clients currently wary of stock markets, a challenge for advisers may be ensuring that client portfolios are not too heavily weighted toward cash and other lower risk investments to the extent that future investment growth prospects may be muted.
It is possible to earn interest of more than 2.5 per cent a year on variable rate cash Isas. This may seem attractive to clients with base rates still sitting at 0.5 per cent a year and seemingly unlikely to move any time soon. However, even with the tax-free interest provided by an Isa, these returns are still below the rate of inflation, meaning savers are actually losing money in real terms. Also, savers need to be aware of temporary bonuses offered on many of the products advertising the best rates, which after they disappear could leave rates looking pretty uncompetitive.
Savers can improve the return they get on cash Isas if they are prepared to lock their money away for a longer period. Rates of about 3 per cent a year are available for a one-year term and more than 4 per cent a year over five years. While the highest rates may appear reasonable, there is not a huge difference between shorter-term and longer-term fixed rates and so it may be sensible to keep some degree of flexibility and perhaps, if prepared to tie money up, clients should be looking at a one or two-year period. After all, rates are unlikely to fall much further from here and so they should not be unduly disadvantaged when they look to reinvest at the end of the term.
Even without interest rate rises, the returns from cash Isas will start looking better for clients if inflation falls in 2012 as many are expecting. It could be that savers start to see real returns from cash savings. However, there is an important caveat to this and it is that many cash savers are older clients whose own personal rate of inflation is likely to be greater than the quoted retail prices index or consumer price index. This is because these people are likely to spend a higher proportion of their money on items such as food and utilities, which tend to rise in price faster than the rate of inflation. This will make it more difficult for them to achieve a genuine real return from cash savings.
It is important for everybody to have some money in cash, even if it is just to cater for short-term emergencies or requirements. If clients hold money in cash it then makes sense to have it where they get a competitive rate of interest and pay as little tax as possible.
Limitation
It could be argued that there is limited benefit in having cash Isas when interest rates are so low. However, it needs to be remembered that the cash Isa wrapper will still be effective next year, the year after and further into the future. The more money that can be held in cash Isas, the greater the tax savings will be, especially when interest rates do start to rise again, which they surely will at some point.
So, with a combination of savings rates which are becoming more competitive compared with inflation and clients reluctant to take investment risk, we can expect significant sums to be invested in cash Isas between now and the end of April as clients look to use up both this year’s cash Isa allowance of £5340 if they have not already, and then next year’s allowance of £5640.
Of course, money invested in cash Isas now can always be switched into stocks and shares Isas in the future. IFAs can effectively manage such a move for their clients. However, there is a danger that for many people, especially those making their own investment decisions, that they will look to switch from cash to stocks and shares only when they have restored confidence in the stock market. To put it another way, they are more likely to invest in equities when stock market gains have already been made and perhaps just as shares are about to fall again.
For those investors who have been using their stocks and shares Isa allowance over the past 12 months, their focus has been predominantly on lower risk investments such as good quality fixed interest and cautious managed funds, or mixed investment 20 per cent to 60 per cent shares funds if you prefer.
We are now seeing more interest in equity income funds, which is positive as they are paying decent levels of income and can form a core part of many client portfolios. This increased activity in equity income funds is also spreading to overseas equity income offerings resulting in some investment companies rushing to launch new products. However, there is still a distinct lack of interest in higher risk equity and fixed interest sectors where there is potentially the best value, this despite the bounce we have witnessed to date in 2012.
As we approach the end of the tax year we can still expect investors to be focused on more cautious assets, although perhaps with signs that some are now dipping their toes into riskier areas, particularly if markets continue to push upwards.
As any IFA will tell you, the right approach, of course, is not a particular asset class or fund but rather having the right mix of investments to meet a client’s overall financial objectives and attitude to risk. Unfortunately those investors who make their own decisions without having an IFA to guide them often do not appreciate this and make investment decisions based on short-term past performance and driven by greed or fear. This is why we saw increased interest in gilt funds toward the back end of 2011.
So for those advisers looking to utilise their clients’ Isa allowances for this tax year and also to invest next year’s allowance shortly after 6 April, and particularly for execution-only brokers that experience more of an “Isa season”, we can expect continued demand for perceived low-risk assets and funds. Other than cash, this will include cautious managed, absolute return, corporate bond, strategic bond and fund of fund offerings. We may also see further demand for equity income funds.
There may start to be renewed interest in riskier areas such as growth stocks, emerging markets and smaller companies if stock markets continue their rise of the start of the year. However, if markets slump again or show further volatility, which is very likely, then many of those who were making tentative steps toward taking more risk, rather than seeing any market falls as a buying opportunity, are likely to turn around and head for the hills, well, for cash and fixed interest at least.
Patrick Connolly is head of communications at AWD Chase de Vere
