A Cash ISA has looked like an attractive option in the past couple of years, with the best ones offering tax-free passive income of around 5% per year.
They’ve taken investors’ cash away from the stock market, and that’s no surprise. After all, Cash ISA interest is guaranteed… at least for the duration of the deal.
Why risk losing money just to chase a few more percent in stocks and shares? For the short term, why indeed? But for long-term investments, I think there are good reasons.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Risk vs reward
Cash ISA returns look good now, but when interest rates get back to their long-term trend that will surely change.
Meanwhile, the FTSE 100 has managed a long-term average annual return of about 7.5%, with the FTSE 250 coming in at 11%. And they’ll surely look even better when Cash ISAs get back to a measly couple of percent.
Now, both of those stock market indexes come with risk. And we usually see the smaller stocks of the FTSE 250 as carrying higher risk than the bigger FTSE 100 ones. So I’m not going to pile every penny I have into them. But I’m happy to buy and hold some as part of a diversified Stocks and Shares ISA.
And even if I don’t have the cash to use my full ISA allowance, I can dream about putting that much into FTSE 250 stocks, can’t I?
Long-term returns
Is there one I could use as an example of how dividends and price gains can compound up to a fat pile of cash?
I see abrdn (LSE: ABDN) has a forecast dividend yield of 9.6%, so it wouldn’t take a lot of price gain to reach that 11% long-term index average. And the share price is down over five years, so is this a chance to get in cheap?
It’s an investment company, and I’d expect its earnings and share price to be more volatile than the market itself. When stocks are rising, more people pump cash into firms like abrdn and they can beat the market.
But then, in down spells, shareholders can sell up and push investment management stocks right down. It’s really not nice looking at how similar stock prices fell while inflation and interest rates were climbing.
Passive income
Anyway, what might I earn from putting £20,000 into abrdn shares, just from the dividends? Assuming the yield were to stay at 9.6%, a one-off sum like that could grow into £125,000 in 20 years. And that could then pay me my £1,000 per month in passive income.
If I could hit the FTSE 250’s 11% average, I could boost that to £1,400. And even the FTSE 100’s 7.5% could add £530 to my income each month.
I’d never put all my eggs in one basket. And I’d only buy a stock like abrdn as part of a diversified ISA. But doing sums like this convinces me that shares are a much better option for long-term returns than a Cash ISA.
