Since the Bank of England nudged interest rates up to 5%, I’ve been looking at the knock-on effect for savings accounts. One question, in particular, stands out to me. Would a Cash ISA generate better earnings than a Stocks and Shares ISA?
What could I earn in savings accounts?
First, let’s look at how much I’d earn with a Cash ISA. Sadly, rates being at 5% doesn’t mean I’d earn that much. The BoE’s Base Rate sets the amount of interest paid to commercial banks, but the full amount isn’t always – or ever – passed on to the customer.
The ‘big four’ banks are the worst for this. One of them – with which I have a current account – just sent me an email with the “good news” that the interest on its Cash ISA has increased to 1.36%. Safe to say I didn’t take it up on the offer.
Smaller banks are better in this respect. Easy access Cash ISAs go up to around a 3.8% return. One-year fixed ISAs can reach up to around 4.9%. Some banks even offer the full 5% but with a hefty minimum deposit requirement.
So, I could earn close to 5% interest a year in interest that’s safe and guaranteed. But will I earn more than with a Stocks and Shares ISA?
Investing in UK shares
Perhaps I could. While a Cash ISA offers a fixed amount, investing in the stock market is unpredictable. There are boom years and bust years, good companies and bad companies. The amount I will earn is impossible to say.
That said, many investors in UK shares would consider a 5% return to be a substandard return.
For one, a lot of UK companies offer more than that in dividend payments. For example, BT offers an annual yield of 6% and Aviva offers 8%. Actually, by my count, 29 of the FTSE 100 firms have a 5% dividend or higher right now.
And that’s only part of the equation. Many shares offer growth opportunities as well, which means the shares I own would be worth more. The difficulty is that stocks are volatile. It’s impossible to guarantee a yearly return.
I think it’s best to look at total returns from UK shares over time. Looking at recent decades, the big FTSE 100 firms have offered an average of 8% per year. The smaller, more UK-focused FTSE 250 firms have offered roughly 10%.
The long and short of it is that a Stocks and Shares ISA is the winner here – for me, at least. Over the long term, I’d expect more than 5% from investing in UK shares, although this comes with a caveat.
A caveat
One important thing to mention is the return from a Cash ISA is guaranteed. Returns from investing in UK shares aren’t a certainty. Let’s say the stock market crashes in the next year or two, then I’d expect to earn more from a Cash ISA.
What it comes down to is both types of ISA have their uses. And actually, I did open a Cash ISA recently. The return looked decent enough for a little spare cash I had lying around. Overall though, I still think investing in UK stocks has far greater wealth-building potential.
