Should You Compound Interest on Your ISA?
Should You Compound Interest on your ISA?
Cash ISAs are typically used by people that are prepared to accept limited returns on their capital in exchange for certainty of returns and for not exposing their money to investment risks. They are often used for short-term savings goals, rather than as part of a long-term saving/investment strategy. Given the volatile nature of the stock market, investors are inclined to hold their money in a stocks and shares ISA for longer. This helps mitigate risk by capitalising on long-term value growth rather than short-term fluctuations. However, you are not guaranteed a specific return: stocks and shares ISA providers can’t offer fixed or consistent returns. Of course, your choice of ISA – and how long you choose to make use of one – all depends on your saving or investment goals. If your aims are short-term, then simply receiving your interest at the end of your chosen term might be just right for you.
But, if you’re planning to invest for a long-term goal such as your retirement, receiving your interest from your ISA regularly doesn’t make all that much sense. A far better option would be to compound the interest on your ISA.
Compound Interest and the ISA
Compound interest, fondly known as the ‘savers’ best friend’, is interest earned on interest. As the principal value of your ISA changes over time, by taking advantage of compound interest, you can maximise your returns far faster, building up larger amounts of interest over the long-term. Combine this with the tax-free savings enabled by ISAs, and it’s not hard to see why this offers such an attractive option. By way of comparison, simple interest is earned on the principal investment amount only and doesn’t take into account any increases or decreases in that amount over time. So, if you invest £1,000 in your ISA at a 2% annual interest rate, you’ll earn £20 every year for as long as that investment ticks over. If we use that same example to demonstrate compound interest; the £20 you earn in year one on your principal investment amount of £1,000 increases its base value to £1,020. This means that in year two, your ISA is earning 2% interest on £1,020 which equals £20.40. Your investment amount continues to increase which, in turn, pushes up the amount of interest you earn, which increases your investment amount and so on.
One of the crucial benefits of compound interest, particularly for people interested in cash ISAs, is that it can help outstrip inflation. Without compound interest, the returns offered by most cash ISAs would simply be eroded by inflation. By adding compound interest to your ISA, you can really boost your long-term savings. It can help you maximise the frankly meagre returns on cash ISAs, as well as provide some protection from the volatility of stocks and shares ISAs. While the volatility of the latter can deliver high returns, these are far from guaranteed. But why not consider an alternative ISA option, and take advantage of compound interest at the same time? The Innovative Finance ISA (IFISA) could be just what you’re looking for.
What is the IFISA?
The IFISA, first launched in April 2016, is a peer to peer lending ISA that broadens your ISA options. With The House Crowd’s IFISA, you can earn 7% interest* tax-free every year on an investment of up to £20,000, over a minimum investment period of three years (subject to terms & conditions). Not only does it offer better rates than cash ISAs, it also offers less volatility than the stock market. That’s not to say it’s risk-free: as with any investment, the IFISA does present some risks – however, by spreading that risk through portfolio diversification, you can reduce the impact on your money from unexpected downturns or borrower defaults. By investing your ISA allowance into an IFISA, you can benefit from access to FCA-regulated peer to peer lending and receive tax-free interest in return. At The House Crowd, our secured peer to peer lending platform lends money in the form of bridging loans to property owners and developers. We make sure to further secure your investment in these loans with a legal charge over the borrower’s property asset.
**When you compound interest within your IFISA it is reinvested, which means that it joins your original capital in being ‘at risk’.