If you are looking for somewhere to stash your savings, a Cash ISA might seem attractive. Indeed, it’s an excellent tool for investors because any interest earned inside the ISA wrapper doesn’t attract tax.
You don’t even need to declare the interest received on your tax return. That’s especially attractive for higher and additional tax rate payers who might have to fork out as much as 45% tax on any interest received over the tax-free limit of £500 on funds outside an ISA.
However, while a Cash ISA might look attractive from a tax perspective, from an investment perspective, it’s not a particularly exciting product.
At the time of writing, the best interest rate on the market is just 1.8% per annum, and that’s only available if you are willing to lock your money up for a year. If you’re prepared to lock your money up for five years, you could get as much as 2.3%, but that’s still not particularly attractive in the grand scheme of things.
Time to look elsewhere
A paltry interest rate of 1.8% per annum isn’t enough to tempt me into taking up a Cash ISA, and that’s why I’m ignoring the products available on the market today and putting my money in the FTSE 100 instead.
Compared to the current rates of return available from the Cash ISAs, the FTSE 100 is much more attractive, in my opinion.
For a start, at the time of writing, the index supports an average dividend yield of around 4.5%, more than double the best one-year fixed Cash ISA rate.
On top of this, I’m excited by the potential capital gains opportunities investing in the FTSE 100 offers. While there’s some risk that, in the short term, the index might go up and down, over the long term, company profits should grow in line with inflation at the very minimum.
Higher profits should justify higher earnings per share which, in turn, should lead to higher share prices. This implies investors can look forward to capital growth of between 2% and 3% every year over the long term in the base case. Including dividend income, these numbers suggest the FTSE 100 will return between 6.5% and 7.5% per annum over the long run, which is roughly in line with the index’s average annual return over the past two decades.
Focus on the long term
Unfortunately, I can’t say what the index will do over the next 12 months or even two years, and we could see plenty of volatility during this period as the UK continues to negotiate its divorce with the European Union.
However, over the next decade or so, I’m confident the FTSE 100 will rise substantially from current levels at an average annual rate of 7% or more.
That’s why I’m ignoring the Cash ISA and buying the FTSE 100 instead. Over the long term, I’m highly confident the index will produce a substantially higher return than any Cash ISA available on the market today.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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