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Forget 1% from a Cash ISA. I’d pick up 25% risk-free from this ISA

Edward Sheldon, CFA
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Cash ISAs are extremely popular with UK savers and for many people, they remain the savings vehicle of choice. This is illustrated by the fact that at the end of the 2017/18 financial year, approximately £268bn was held in them.

Yet with the average Cash ISA paying just 1.32% in interest right now, holding a large proportion of your wealth in one could be a huge mistake, in my view, particularly if you’re saving for the long term. I say this because UK inflation came in at 2% in June, and has averaged close to that all year, meaning that any money sitting in a Cash ISA is effectively losing value over time.

Of course, having some cash savings is important. Cash gives you options and is essential for emergencies. However, with interest rates of just over 1% on offer right now, Cash ISAs have little appeal, to my mind.

The Lifetime ISA

Personally, I’m a much bigger fan of the Lifetime ISA. This has several major advantages over the cash variety.

First, unlike the Cash ISA, the Lifetime ISA enables you to hold a wide range of growth investments such as stock and funds. This means that it’s possible to earn a much higher return on your money.

For example, in a Lifetime ISA, you could hold a selection of FTSE 100 dividend stocks such as Royal Dutch Shell and Lloyds Bank. Right now, these stocks offer dividend yields of 5.8% and 6% respectively – over four times the average Cash ISA interest rate.

Alternatively, you could buy an investment fund such as Fundsmith Equity fund. This particular option has returned over 70% in the last three years alone, although past performance is no guarantee of future performance.

A 25% risk-free return

Yet where the Lifetime ISA really comes into its own is the fact that for every pound you contribute, up to £4,000 per year, the government will add in 25p for you. Put in £100 and you’ll pick up £25 for free. Put in £1,000 and you’ll pocket £250 for free. Contribute the full £4,000 allowance and you’ll pick up a huge £1,000 for free! That’s a 25% return for doing absolutely nothing. That sure beats the 1% on offer from Cash ISAs, in my view.

What’s the catch?

Now, of course, a great deal like this doesn’t come without a catch. There are a few important details you need to know about. Firstly, you can only open a Lifetime ISA if you’re aged between 18 and 40. Secondly, you can’t withdraw your money (without harsh penalties) until you either turn 60 or buy your first property. In other words, the Lifetime ISA is designed to help you save for your first house or for retirement. As such, it won’t be for everybody.

However, if you are saving for retirement, or for your first home, it could certainly be worth considering as a savings vehicle. A risk-free 25% return plus the opportunity to grow your money through stocks and funds certainly beats 1% from a Cash ISA, to my mind. 

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Edward Sheldon owns shares in Royal Dutch Shell and Lloyds Banking Group and has a position in Fundsmith Equity. The Motley Fool UK has recommended Lloyds Banking Group. 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