Cash Or Shares ISAs?

The ISA deadline for this year is only three weeks away. Should you put your ISA money into cash or shares?

I think the ISA is a fantastic tax break. So if you've been thinking about taking out an ISA for this tax year, you should get cracking. 5 April is the last day for applications.

Current rules allow savers to put up to £3,000 in a cash ISA, which is just like a conventional savings account except it's tax free! On top of that, you can invest up to £4,000 in a shares ISA. Or you could invest the whole £7,000 in the stock market if you prefer.

So which is better? Cash or shares?

Well, for me, shares are best. I've already invested my whole £7,000 allowance for this year in a shares ISA, and I'll do the same next year. That's because all the historical evidence suggests that shares outperform the return from savings accounts over the long-term.

Look at these numbers from the 2007 edition of The Barclays Equity Gilt Study. Over the last 50 years, shares have delivered a real (after inflation) return of 7.1% a year whereas cash has only beaten inflation by 2% a year.

Shares have also out-performed cash over many shorter periods. Over the last 10 years, the average real return from shares is 4.9% a year compared to 2.6% a year from cash.

What's more, fund management group Fidelity has compared the performance of cash ISAs to shares ISAs since ISAs were introduced in 1999.

If a saver had contributed £3,000 a year since April 1999, his cash ISA pot would now be worth £26,000 whereas the same contributions in a UK tracker ISA would now be worth £36,000 -- that's 39% more than the cash saver.

A tracker is a low cost investment vehicle that mimics the performance of a particular stock market index such as the FTSE All Share index. The cheapest UK tracker fund right now is the Fidelity Moneybuilder UK Index fund which has a Total Expense Ratio (TER) of just 0.3% a year.

But if you'd prefer to do your own stock picking, you can do that within an ISA too. You can buy individual shares or investment funds within a Self Select ISA. Here at The Fool we provide our own Self Select ISA service where you can trade online for a flat fee of just £10 a trade.

That said, investing in the stock market isn't for everyone. If you think you might need your ISA fund within the next five years, you should probably put your money in a cash ISA. Although stock markets normally perform well in the long-term, they can be volatile over shorter periods. So if you wanted to withdraw money from your shares ISA in two years' time, you might find the value of your savings had fallen over that period.

There's also a personality issue here. If you saw a report on The Ten O Clock News which said that share prices had slumped 10% that day, would you be able to sleep that night? We advise Fools not to worry unduly when these falls happen as they're inevitable every so often, but if you think you'll fret nonetheless, shares probably aren't for you.

Still, regardless of whether you go for shares or cash, it makes sense to take advantage of the ISA tax breaks if you have any spare money to save.

More: Your Guide To Best Buy Cash ISAs | How To Become A Great Investor