Forget a Cash ISA! I’d invest £20,000 in a Stocks and Shares ISA to earn passive income for life

If I had a £20,000 sum to invest, I think a Stocks and Shares ISA is a far better option for passive income than a Cash ISA. Here’s why.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Midnight is celebrated along the River Thames in London with a spectacular and colourful firework display.

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The Bank of England raised interest rates to 4% last month, their highest level for 15 years. And even with these higher returns, Cash ISAs still seem like a terrible deal to me. If I wanted to build passive income from my savings, I’d invest in a Stocks and Shares ISA instead. Here’s why.

42p interest a month

Several years ago, I opened a Cash ISA after saving a few pennies from my first real job. I wanted to be smart about my money, invest for the future, and maybe start building up enough cash for a deposit to buy my first home. 

I got a shock when I opened my online banking account after the first month. My Cash ISA, which had maybe £3,000 deposited, gave me back only 42p in interest for the month. I felt so disappointed. Not even a tenner a year. How would that help me save for a house deposit?

The poor returns were partly due to the low interest rates back then. Fast forward to 2023, and we have a 4% interest rate. So are Cash ISAs a good deal now?

Cash vs stocks

An article published in The Guardian last year showed that only two out of 233 savings accounts passed on the full interest rates rise to customers. Even now, the highest rate I can find on a Cash ISA is 3.1%.

When I purchase shares in a Stocks and Shares ISA on the other hand, it’s a much more even playing field. I get the full returns minus a one-off trading fee. And with historical returns in British large-caps on the London Stock Exchange being around 8%-10%, I feel the gains are much more lucrative too. 

Let’s compare the returns of a Cash ISA and a Stocks and Shares ISA with an initial £20,000 stake.

Cash ISAStocks and Shares ISA
Percentage Return3.10%9%
Starting Amount£20,000£20,000
10 years£27,140£47,347
20 years£36,830£112,088
30 years£49,979£265,354

The stark difference between how much 9% and 3.1% earns – over £200,000 in interest – shows clearly why I think owning stocks is a better way to build long-term wealth. 

There are more risks involved with investing in stocks. Historical returns may not be the same as future performance. And an advantage of Cash ISA is that returns are guaranteed, which makes them much more suitable for short-term saving.

A passive income source

At some point, I will want to withdraw funds to create a passive income. A useful phrase here is ‘safe withdrawal rate’. This is basically how much I could take out while keeping my original sum more-or-less intact. Studies have shown 4% to be safe over multiple-decade timeframes.  

The 4% safe withdrawal rate of that 30-year figure of £265,354 offers a £10,614 income per year. That’s nearly £900 a month from investing in stocks, an amount higher than the state pension. I’d like that as an extra income source over the long term. 

I’ve been working towards a future income like this for a few years now and the reality is not as cut and dry as the example above. But by ‘drip-feeding’ spare cash into stocks and investing in quality companies? I’m seeing real progress towards what I hope will be a lifelong passive income.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

John Fieldsend has no position in any of the shares 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.

More on Investing Articles

Illustration of flames over a black background
Investing Articles

Down 75%! Will the Saga share price ever be loved again?

The last few years have been incredibly difficult for those watching the Saga share price. But what does the future…

Read more »

Investing Articles

What kind of return could I expect by investing £100 monthly in a Stocks and Shares ISA?

Using a Stocks and Shares ISA to avoid capital gains tax could grow a £100 monthly investment into a second…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

Can strong operational momentum keep the Informa share price rising?

FTSE 100 company Informa has been performing well, but this may be just the beginning of a multi-year trend for…

Read more »

Market Movers

What’s going on with the Britvic share price?

Jon Smith flags up why Britvic's share price is surging on Friday, but believes that the company is in a…

Read more »

Cheerful young businesspeople with laptop working in office
Dividend Shares

2 super-cheap passive income shares I’m eyeing up right now

Jon Smith discusses two of his favourite passive income shares in the banking and property sectors, both featuring yields above…

Read more »

Chalkboard representation of risk versus reward on a pair of scales
Investing Articles

Up 37.5% in just 12 months, I think this is one of the FTSE 100’s best investments

Our author says this FTSE 100 company is likely to keep on capitalising on the AI and data boom. But…

Read more »

Investor looking at stock graph on a tablet with their finger hovering over the Buy button
Investing Articles

This UK share just spiked 15% on bid news. Can we bag a quick profit?

UK share prices are having a good 2024, so far, and this one's already up 39%. Two takeover bids in…

Read more »

Young Caucasian man making doubtful face at camera
Investing Articles

I’m ‘blowing a raspberry’ at Raspberry Pi shares. Here’s why

Some early investors have made great profits from Raspberry Pi shares. But our writer's questioning whether the 'easy money' has…

Read more »