While the FTSE 100 has historically offered an income return that is attractive when compared to a Cash ISA, the difference between the two investments is currently relatively wide.
In fact, while a Cash ISA can be expected to return 1% per annum on average at the present time, there are 26 shares in the FTSE 100 with yields over 6%. This means that an investor could realistically build a portfolio of large-cap stocks that, combined, has a dividend yield in excess of 6%.
Certainly, there are greater risks facing investors in shares versus a Cash ISA. But the index could also offer capital growth potential in the long run.
Income returns
While a 1% return from a Cash ISA may increase over the long run as interest rates rise, the UK is expected to maintain a loose monetary policy over the coming years. The Bank of England may wish to remain supportive of the economy at a time when political risks are heightened, and this could lead to it delaying interest rate rises.
In fact, UK interest rates are forecast to be around 1% by 2022. This suggests that inflation is likely to beat the returns on Cash ISAs, which could cause the spending power of cash holdings to decline.
During that time, FTSE 100 shares yielding over 6% could increase their dividends. In many cases, this may be at a higher pace than inflation, which could cause the difference in income returns between stocks and cash to further increase.
Capital returns
While there is no capital loss from having a Cash ISA, there is also no prospect of capital growth. This contrasts with the FTSE 100, which has historically offered a total return that is in the high single-digits on an annualised basis.
For example, the index has risen seven-fold since its inception in 1984. Although not every investor will have such a long-term horizon, those who are able to overcome the ebbs and flows of the index in the short run are likely to be rewarded by a relatively high rate of growth in the long run.
Moreover, with the world economy continuing to grow at a robust pace, a number of large-cap shares could prove to be cheap at the present time. This could further enhance their return potential, with them offering favourable risk/reward opportunities in many cases.
Future prospects
While the potential for a global trade war could lead to increasing volatility for investors in FTSE 100 companies, the return potential they offer could mean their overall appeal is high.
By contrast, a Cash ISA looks set to lack attractive returns over the medium term. This could inhibit its ability to offer a passive income, as well as capital growth, for a variety of investors.
As such, now could be the right time to invest excess capital in a range of FTSE 100 dividend shares and hold only modest amounts of money in a Cash ISA.