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Don’t use a Cash ISA to save for retirement! Here’s a better way to boost your State Pension

Peter Stephens
A person holding onto a fan of twenty pound notes

With numerous risks facing investors at present, having a Cash ISA may seem to be a good idea. There’s no risk of loss, provided you have less than £85k held at one banking group, and many savers may be of the view that interest rates will become more attractive over the long run.

However, the stock market’s track record shows it could deliver far superior returns than a Cash ISA over the long run. As such, while there may be volatility ahead in the coming months, buying undervalued shares now for the long term may improve your prospects of beating the State Pension.

Cash ISA prospects

Interest rates have been close to historic lows for over a decade. This means that the income return available on Cash ISAs is currently lower than inflation. Over the long run, this situation may change. Interest rates are, after all, unlikely to persist at such a low level in perpetuity.

However, the speed at which they rise may cause disappointment for many savers. With global economic risks high, and inflation around 2%, there seems to be little incentive for the Bank of England to raise interest rates at a brisk pace.

The end result could be that money held in a Cash ISA fails to produce a retirement nest egg which provides a realistic supplement to the State Pension in older age. Its returns may simply fail to keep up with inflation, which may inhibit its ability to provide an income that can offer financial freedom in older age.

Stock market potential

Although the stock market looks set to experience an uncertain 2020, as global- and UK-focused risks are at a relatively high level, its long-term prospects seem to be highly encouraging.

The FTSE 100 and FTSE 250 are cyclical investments and have historically fluctuated between experiencing bull and bear markets. This is unlikely to change, so the uncertainty facing investors today may present a buying opportunity for the long run. They may be able to purchase undervalued shares which, in many cases, offer impressive long-term earnings growth potential.

Through buying a range of such companies, it may be possible to reduce the risk of one holding having a negative impact on the wider portfolio. This may enable an investor to build a retirement portfolio that offers a favourable risk/reward opportunity, as well as attractive returns that ultimately produce a more favourable retirement outlook.

Certainly, short-term volatility means there may be periods where a Cash ISA appears to be a better investment due to its more consistent return profile. But anyone with a long-term outlook until they are likely to retire may benefit from building a portfolio of FTSE 350 shares that can beat inflation, as well as reduce their reliance on the State Pension.

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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.

Motley Fool UK 2019