Cash illustrations - are they needed?

Lured by tax free returns and encouraged by ever-rising contribution limits, regular savers could easily have over £50,000 in their cash Isa fore they use their 2017 allowance.

Looking nationally, the HMRC savings statistics suggest that there is around £270bn in cash Isas; a staggering amount in a hugely popular investment.

However, the landscape has changed from 1999 when cash ISAs were created. In those days, with interest rates at over 6 per cent and inflation under 2 per cent, they were the proverbial no-brainer for clients.

This positivity continued until 2008/9, when interest rates fell from over 4 per cent to under 1 per cent. Most savers will know the rates have fallen and grumble accordingly, but few could tell you their current rate and fewer still, truly understand what inflation is doing to their savings.

The FCA's requirement for communications to be clear, fair and not misleading should not be ignored.

The chart below overlays inflation, using the retail prices index onto the average cash Isa rate. Many cash Isa savers would be surprised to see what’s happened since 2009.

A suggestion for more illustrations might not land well with the adviser community. However, without them, savers will continue to hunt down the best rate and still lose money in real terms. 

I looked at one building society website, whose cash Isa was paying a reasonable interest rate in today’s terms of 0.75 per cent and they position it as follows:

• What would the estimated balance be after 12 months based on a £1,000 deposit?
• Based on the fixed rate of interest, if you deposited £1,000 into this account, after 12 months you would have £1,007.50.
• This means you’ll receive £7.50 interest if you leave £1,000 with us for a whole year.

But if you take inflation into account, assuming the current rate of RPI at 2.5 per cent, your £1,007.50 would actually be worth £982.31.

So in summary, while you think you’ll make £7.50, you’ll actually lose £17.69. With such openness, it’s hard to believe that anyone would invest in this cash Isa.

But of course, there is no such openness, as only the first two bullets are actually disclosed to savers.

Having recently launched a cash Isa vs stocks and shares illustration tool in our software, it’s been interesting to share views on the rates to use with advisers. 

It’s easy to fall into the trap of projecting the current miserable rate for cash Isas. But the FCA's requirement for communications to be clear, fair and not misleading should not be ignored. The average rate is currently 0.46 per cent, but for a projection of 5+ years, I’d be inclined to use 1 per cent and maybe as much as 1.5 per cent.

Stocks and Shares Isa growth rates – These rates should be the standard FCA rates of return for untaxed investments, so with a range of 2 per cent, 5 per cent and 8 per cent, most would settle on the mid-rate of growth at 5 per cent.

However, it is interesting to consider a worst case scenario at 2 per cent, as this can expose where product, fund and adviser charges eat too heavily into the potential returns.

In terms of inflation, the FCA prescribes a rate of 2.5 per cent for inflation. The effects of the Brexit vote, could suggest this rate is low for a 5+ year projection, but until the FCA decides otherwise, who’d go against this?

I need to stress I’m not advocating a wholesale switch from cash Isas to stocks and shares Isas. After all, the vast majority of elderly savers wouldn’t dream of taking any risk at their time in life.

The rest, however, could do with understanding the impact of inflation and consider investing in accordance with their true risk profile.

Graham Miller is managing director of O&M Systems