Thanks to the the Bank of England raising interest rates, Cash ISA rates have risen significantly over the past year. Fixed-rate Cash ISAs now pay well over 4%, making it a harder choice between stashing money there versus investing in dividend stocks. With the FTSE 100 average dividend yield currently at 3.7%, where’s the best place to make passive income at the moment?
Comparing the yield potential
On the face of it, an investor might assume that a Cash ISA is the best place to invest, given the higher yield versus the FTSE 100 average. This is true if the person wanted to buy a tracker with all the FTSE 100 stocks in it and was looking for the safety of guaranteed returns.
However, for active investors, this doesn’t hold true. If one discounts the 10 stocks in the index that have a dividend yield of less than 1%, the average yield of a potential portfolio jumps significantly.
Another element is to increase some allocation to the stocks around which an investor has a high conviction. They don’t have to put the same amount of money in every stock. For example, by parking more money in higher-yielding shares than lower ones, the average yield again moves up.
I don’t think it’s reasonable to aim for a portfolio with a 9%+ yield. Yet I feel that with a diversified mix of shares, a yield of 6% is definitely achievable.
So when I compare the Cash ISA potential with a 6% yield, the picture changes and makes stocks seem a more appealing option.
Risk but also reward
Some will cite the risk with stocks as the value of the capital invested could fall. This is true. With a Cash ISA, the amount invested is safe and won’t fluctuate in value.
But shares aren’t just about the yield. For example, take HSBC. The global bank has a dividend yield of 5.48%, meaning that most income investors would probably be interested in buying the stock. Over the past year, the share price has jumped by 25% too!
Granted, this is just one example. But there are plenty of other similar cases in the FTSE 100 where a stock has an attractive dividend yield but has also seen share price gains in the recent past.
Ultimately, this means that even though the amount invested could fall in value, it could also rise. So it’s a risk/benefit that needs to be appreciated and fully understood by someone before making a decision.
My overall view
Given the enhanced yield and potential for share price growth, I still prefer dividend stocks over a Cash ISA. They aren’t mutually exclusive though. Someone can invest in both partially, to try and obtain the best of both worlds.
As with most things in financial markets, it’s a subjective choice depending on the risk tolerance of a particular person and their investing goals.
