While saving money in a Cash ISA may seem to be a worthwhile move, doing so can lead to disappointment in the long run. Put simply, the returns on a Cash ISA are exceptionally low, and may lead to the loss of purchasing power for those who use them.
By contrast, investing through a Stocks and Shares ISA could lead to wealth creation in the long run. Certainly, there are greater risks in the short run, but the difference in potential returns could make a Stocks and Shares ISA more attractive than a Cash ISA.
Although the idea that a Cash ISA destroys wealth may seem to be somewhat far-fetched, inflation continues to be above the returns available on cash product. This means that, over time, money held in a cash version of your ISA is losing its purchasing power.
For example, with the best Cash ISAs offering an interest rate of around 1.5%, every £1 invested can purchase fewer goods and services over time as a result of inflation currently standing at 1.9%. As such, while it makes sense to have some capital in cash for emergencies, relying on it to improve your financial position in the long run may lead to a disappointing outcome.
Investing through a Stocks and Shares ISA instead can lead to wealth creation in the long run. Even if the rate of inflation spikes over the medium term, the FTSE 100 and FTSE 250 are likely to offer positive inflation-adjusted returns.
For example, over the last 20 years the two indices have recorded total annualised returns of around 5% and 9% respectively. Although their performances may ebb and flow depending on the economic outlook, investors who have a long-term outlook are likely to benefit from significantly higher returns than for a Cash ISA.
Ease of use
While opening a Cash ISA is a relatively straightforward process, so too is opening a Stocks and Shares ISA. With the cost of online share-dealing having fallen significantly in recent years, it is possible to set up regular investments of relatively small amounts. They can be invested in tracker funds, which spread the risk among a variety of stocks for a small charge, or in company shares.
Clearly, investing in the stock market through a Stocks and Shares ISA is a riskier proposition than having a Cash ISA. There is a risk of capital loss, which is not present for a cash version. However, the risk of losing spending power over the long run is a very real threat facing savers, which could mean that investing in the stock market is a better idea.
As such, now could be the right time to open a Stocks and Shares ISA and start investing, rather than continuing to lose money when inflation is factored into the returns on a Cash ISA.
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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