ISAs have grown to become one of the UK’s favourite investment strategies in recent years, but what happens when an economic downturn
threatens your profitability? And what type of individual savings account offers the most resilience in the face of a recession?
Whether you prefer the relative security of fixed-rate Cash ISAs or the earnings potential of Stocks and Shares ISAs, both can be impacted by economic downturns and recessions.
For Cash ISA holders, the threat of a recession can lead to falling interest rates that lead to losses in real terms when it comes to growing your wealth ahead of inflation. The hazards facing Stocks and Shares ISA holders focus on the threat of stock market
sell-offs from investors and contracting economies, causing more companies to lose money and prompting weaker market performance.
When the UK entered a recession amid the shock of the COVID-19 pandemic in 2020, as much as
22% of investors either sold their investments or claimed that they planned to sell their holdings amid the crisis.
Despite the United Kingdom entering two recessions, both spanning two quarters, in 2020 and 2023, respectively, we can see evidence of resilience for both Cash and Stocks and Shares ISAs.
This tells us that it’s important to avoid panicking if you already have money in an ISA, and selling up could run the risk of deepening your losses or incurring withdrawal charges that further impact your ability to achieve your financial goals.
So, what should you do with your savings when a recession hits? And what type of ISA is best during a market downturn? Let’s take a deeper look at the historical performance of Cash and Stocks and Shares ISAs to better understand how they perform in challenging
market conditions:
ISAs to Match Your Goals
Even during a recession, different ISAs can offer various advantages in reaching your specific financial goals.
While there’s no right or wrong answer when it comes to which ISA best suits your needs, the tax advantages of Cash ISAs and Stocks and Shares ISAs, which offer a £20,000 annual tax-free allowance to maximise your saving potential, make them especially attractive
during market downturns.
While Cash ISAs work using fixed or variable rates of return that are in line with the Bank of England’s base rate of interest, Stocks and Shares ISAs are comprised of stock market investments.
As a result, the right choice of individual savings account can depend heavily on your risk appetite and financial goals.
But which is better during a recession? The answer is: it depends on what you’re looking for.
With the benefit of looking back at past performance, we can see that Stocks and Shares ISAs have an average annual rate of return of 9.64% over the past 10 years. This is despite the United Kingdom experiencing two recessions during this timeframe, spanning
four quarters in total.
This means that long-term focused investors with a stronger risk appetite are likely to still grow their wealth even in challenging economic conditions.
However, if you would prefer to avoid risk during market uncertainty, a Cash ISA is an excellent option to generate more predictable returns.
Because Cash ISA rates are fixed, you can easily see your expected tax-free profits in real terms by comparing your Annual Equivalent Rate (AER) with inflation rates. If your returns exceed inflation while you build your savings, you can rest assured that
you’re growing your wealth during a recessionary climate.
Easy Access Could be Key
One of the biggest considerations to take when
subscribing to ISAs during a recession is whether you’ll need swift access to funds should your economic comfort begin to be eroded.
Both a Cash ISA and an
S&S ISA can offer easy access so that you can make a withdrawal at short notice to pay a bill or make an essential one-off purchase, making this savings strategy a suitable option if you don’t have a significant amount of liquidity to fall back on should
a rainy day occur.
While it’s important to maximise your tax-free advantages for your £20,000 annual allowance, you should never look to max out your ISA allowance if it causes you to live from paycheck to paycheck in the process. During a recession, this lack of accessible
funds, even with an easy access savings account, could be damaging to your economic health.
Why Not Both?
Recessions call for more resilient and diversified investment strategies. With this in mind, it may be worth using both an attractive rate Cash ISA and a Stocks and Shares ISA at the same time. This allows you to continue investing in stocks as a long-term
strategy while still enjoying the simplicity and accessibility of Cash ISAs should you need money quickly.
Although Stocks and Shares ISAs don’t require fixed-term commitments, they can take some time to withdraw because of the necessity of selling positions in companies.
While it may seem like sitting on the fence, accessing the benefits of both Cash and Stocks and Shares ISAs at the same time can help you to gain the best of both worlds and be better prepared, no matter how the economic outlook changes in the future.
Preparing for Uncertainty
There’s no right or wrong way to prepare for a recession, and both Cash ISAs and Stocks and Shares ISAs can help you to continue working towards your financial goals even at a time when market conditions appear a little more strained.
Whether you’re interested in the long-term outperformance of Stocks and Shares ISAs or the relative security of Cash ISAs, both individual savings accounts can have plenty to offer while economic conditions tighten.
The choice is yours. But with tax-efficient benefits, whatever the weather, there’s certainly no reason to avoid saving during a recession. With history showing plenty of resilience for ISA returns, your individual savings account remains a great strategy
even amid more challenging environments.
