Motley Fool: This mad dash for cash makes no sense

Chancellor of the Exchequer George Osborne
Chancellor of the Exchequer George Osborne
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When Chancellor George Osborne revealed his changes to the ISA regime back in March, I for one applauded.

Raising the amount you can put into an ISA every year to £15,000 was a bold move I thought would encourage more long-term saving.

And ditching the restrictions on how much you can put into cash versus share ISAs was a much-needed simplification.

I also liked that you’d be able to switch money held in share ISAs into cash ISAs.

Previously you could only go the other way, from cash to shares.

Not everyone believed that simpler, more flexible ISAs would improve our savings habits, however.

I thought being able to switch from shares into cash ISAs would give people more confidence to put money into share ISAs in the first place.

After all, you can now do so knowing that you can go back to the security of cash if you want to.

But others argued that many people wouldn’t have ever put any money into share ISAs, were it not for the restricted cash allowance.

I dismissed that as scaremongering.

It seemed as patronising as claims that the new pension flexibility announced in the same Budget would cause OAPs to trade a secure old age for a sports car now and beans on toast later.

Credit people with some common sense! That’s what I used to think, anyway.

But the Great British Public is already giving me second thoughts.

You see, as I was scanning The Sunday Times at the weekend, I read that the banks are slashing the interest rates paid on cash ISAs – even as savers put more cash in to use their full £15,000 allowance.

For example, National Counties just reduced the interest on its 45-day cash ISA account from 1.9 per cent to 1.45 per cent.

And Kent Reliance has withdrawn its easy-access ISA paying 1.55 per cent on balances over £1,000, replacing it with one that pays just 1.35%.

These are just the most recent cuts. The likes of Natwest and Tesco got the knife out months ago.

The lower rates are set to keep coming, too. An estimated 1.6m Barclays customers will see the rate paid on their Freestyle cash ISAs plunge from 2.76 per cent to just 1.28 per cent in November.

You might ask why the banks are slashing the interest rates they pay on cash ISAs?

Well, I believe it’s simply a matter of supply and demand.

The huge crash in shares in 2008 and 2009 and the talk of financial collapse around the Western world seems to have scared the average person silly.

Here at The Motley Fool, we’ve tried to provide some balance by reminding you again and again of the long-term potential from shares.

In truth, though, even short-term investors have been rewarded.

The FTSE All-Share has roughly doubled since the lows of 2009, including dividends.

Yet most people I meet seem to neither know nor care.

The financial crisis and subsequent recession made them want to save more, yet it also seems to have made them stick with cash, despite the lowest interest rates we’ve seen for 300 years.

As a result, banks and building societies barely need to compete for our money.

Attractive new ISA offers are quickly closed when the banks hit their targets, and savers are left watching their cash ISA money being quietly savaged by inflation.

Of course, it may be appropriate to keep some or even all your money in cash in some circumstances.

The stock market is for longer-term investment, not for money you’ll need in the next few years for a house deposit or school fees (let alone for when your boiler packs up!)

But according to Treasury statistics, roughly half of the £443bn held in adult ISAs in April was in cash ISAs – and that’s after a five-year bull market for shares.

Even leaving aside the derisory levels of interest being paid right now, this flight to cash matters.

Over the long term, the UK stock market has rewarded those who’ve braved its ups and downs with far higher returns:

• According to Credit Suisse’s 2014 Yearbook, between 1900 and 2013, the annualised after-inflation return from cash was just 0.9 per cent.

• In contrast, the after-inflation return from UK shares was 5.3 per cent.

With even the best cash ISAs paying little more than 1 per cent, which do you think is likelier to do best over the next 113 years? The answer might seem obvious.

When selecting shares for your ISA, you ought to consider shares that you’re happy to ‘buy and forget’. To discover five income-producing shares with room to grow, check out our free investor report, Five Shares You Can Retire On.

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