Still relying on a cash ISA? This is what I think you should do

Coworkers standing near a wall
Coworkers standing near a wall

Cash ISAs have been around since 1999 when they replaced the previous tax-protected schemes called TESSAs.

Between 1990 and 2013, there were stringent limitations on cash ISAs. You could only save £3,000 a year (raised to £5,100 in 2010 and then £5,760 in 2013) and any money held within the ISA couldn’t be invested. If you wanted to invest your money, you had to open a separate stocks and shares ISA which had a larger limit of £11,520 in 2013.

However, these constraints were lifted in 2014. That June, the government changed the limits it had placed on cash as well as investment ISAs, allowing savers and investors to put away £15,000 across both. In 2017, the limit was raised further to £20,000.

Further changes

As well as tinkering with ISA limits, the government has also increased the amount of tax investors have to pay on dividends and savings interest income that falls outside an ISA.

Investors are now subject to a tax of 7.5% on all dividend income over £2,000 a year, and basic rate taxpayers have to pay tax on any interest income above £1,000 a year. This drops to £500 a year for higher rate taxpayers.

Let down

All of these changes have only increased the appeal of ISAs. But savers are being let down buy low-interest rates. According to my research, the highest interest rate on the market at the moment for cash ISAs is just 1.4% if you want to be able to access your money at any time.

Still, despite the low-interest rates on offer, cash ISAs remain an essential tool for investors and savers who want to make their money work as hard as possible. However, if you have 100% of your savings in a cash ISA, I think it could be worth investing a portion of this sum to wake up your money in 2019.

Time to invest

How much you choose to invest depends entirely on your risk tolerance. The good news is that today there are so many funds and stocks on the market that you can construct a relatively simple and well-diversified portfolio in just a few clicks of a button. And because ISAs are now flexible, you can leave as much of your money in cash as you want (or invest 100%).

For most investors, I believe a simple investment in the FTSE 100 is the best way to diversify away from cash and improve your returns. At the time of writing, the index supports an average dividend yield of 4.7%. This will give you a steady income stream made up of the dividends from the 100 largest companies listed in the UK, as well as the potential for capital growth over the long term.

Even a small allocation to the FTSE 100 could give a big boost to your income. According to my calculations, moving just 20% of your money into the FTSE 100 would be enough to increase the average yield on your money to 2.1% (assuming a return of 1.4% on the remaining 80%).

If you are willing to take a bit more risk, a FTSE 250 tracker fund might be more suitable. Over the past decade, the FTSE 250 has produced an average annual return in the high single digits but a dividend yield around half of the level of its larger peer.

These are just two small changes you can make to your portfolio to boost your income return in 2019.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.