Cash ISAs can be a great tool to help you save for the future. What’s more, they are extremely popular with savers.
Popular product
According to figures from HM Revenue and Customs, in the 2017–18 tax year, more than eight million savers across the UK opened Cash ISAs.
However, over the past decade, interest rates available on these products have plunged.
The best Cash ISA on the market at the moment offers an interest rate of just 1.31%. It is possible to get a bit more interest if you are willing to lock your money up for longer, but not by much. Even for five-year fixed Cash ISAs, the interest rate is only around 2% on average.
As such, if you are serious about saving for the future, now could be the time to ditch your Cash ISA and invest in the FTSE 100 instead.
Better returns
Over the FTSE 100’s past three-and-a-half decades, the index has produced an average annual total return of 9% for investors.
It is impossible to say if these returns will continue in the short run, i.e., the next two or three years. Nevertheless, over the long term, it is highly probable the index’s returns will align with this historical average.
A combination of both capital growth and dividend income should drive the index higher. At the time of writing, the FTSE 100 supports a dividend yield of 4.3%.
If we take this level of income and add in earnings growth, it is easy to see how the index can achieve average returns of 7% or more every year. Assuming that earnings of the index’s 100 constituents grow at around 3% every year, or in line with inflation, this gives capital growth potential of 3% per annum.
This capital growth potential added to the 4.3% per annum in dividend income gives a total annual potential return of 7.3% over the long term, slightly below the historical average.
Compound interest
This rate of return could do wonders for your finances.
Indeed, an investment of £5,000 in the FTSE 100 for three decades could grow to be worth £44,380. That’s assuming the money grows at an average annual rate of 7.3% throughout the period.
In comparison, the same £5,000 invested in a Cash ISA with an interest rate of just 1.31% would be worth only £7,400 after 30 years. These numbers clearly illustrate why buying the FTSE 100 is a much better option for long term investors than using a Cash ISA.
The FTSE 100 also provides international diversification. Around 70% of the index’s profits come from outside the UK.
So, if the UK’s exit from the European Union does run into trouble over the next 12 to 24 months, the international diversification should provide some cushion for investors.
On the other hand, if the economy slows substantially, the Bank of England will reduce interest rates. That will only further reduce the returns Cash ISA investors receive.