While the interest rates on offer within a cash ISA may have improved in recent months, they still lag inflation. Indeed, it’s difficult to find a cash ISA that currently offers a return of more than 1.5%.
In contrast, the FTSE 100 has a dividend yield of over 4% – even though it’s delivered capital growth in recent months. This is relatively high for the index, and suggests it could offer impressive total returns despite the risks it currently faces.
Threats
Of course, there’s a danger the FTSE 100 could experience a challenging period. There are a number of threats facing the world economy at the present time that may cause investor sentiment to come under pressure.
For example, the US is on a path to higher interest rates. Although the pace of increase may prove to be relatively slow, it could still hurt the performance of the global economy. Countries which have dollar-denominated debt may find it more difficult to repay and service their debt. Meanwhile, a slowing China economy has been a cause for concern over recent years, with its ‘soft landing’ expected to become a reality over the medium term.
There are, of course, continued uncertainties surrounding the European economy. Germany and Italy’s economies offer disappointing outlooks, while Brexit could act as a drag on the UK, as well as the EU’s, performance over the medium term. This could limit the growth capacity of FTSE 100 companies that operate in Europe, and may lead to wider margins of safety being demanded by investors.
Growth potential
While in the short run the FTSE 100 may have an uncertain future, in the long run it appears to offer significant growth potential. This could mean that as well as its 4%+ dividend yield, investors are able to benefit from a substantial amount of capital growth.
The index appears to be undervalued at the present time. Its dividend yield has rarely been higher in the last couple of decades, which indicates that investors may have already priced in the risks that it faces. This could allow it to generate impressive returns over the long run, after what has been a volatile 12-month period.
Of course, a number of FTSE 100 shares offer an even higher income return than the index’s 4%+ yield. This could mean investors are able to treble or even quadruple the income return that’s available from a cash ISA, while also building a diverse portfolio of shares. This could tip the risk/reward ratio further in an investor’s favour, since the additional reward potential offered by a basket of FTSE 100 high-yield stocks could outweigh the additional risk versus holding a cash ISA.
As such, while a cash ISA promises negative real returns, the FTSE 100 could deliver impressive total returns over a sustained period of time.