If you’ve suddenly come into some money, it might be tempting to take out a cash ISA and stash these funds away for a rainy day. Cash ISAs are great because they usually offer better interest rates than savings accounts and any income received is tax-free. You don’t even have to declare ISAs on a tax return.
However, right now cash ISAs do not seem to offer good value for money. According to my research, the best cash ISA available today offers an interest rate of just 1.4% if you are willing to lock your money away.
Considering the current rate of inflation in the UK is 2.7% per annum, this means that even the best cash ISA on the market will not protect your money from the scourge of inflation. After including the impact inflation will have on your money, the real rate of interest is -1.3%.
Even the tax benefits of using a cash ISA do not make up for this negative real rate of return.
Considering the above, I believe that rather than stashing your money away in a cash ISA, the FTSE 100 might be a better buy.
The main reason why I believe the FTSE 100 is a better place to store your money is because of the level of income on offer.
Right now it supports an average dividend yield of 4.4%, which is three times more than the best cash ISA offer. After including the impact of inflation on this income, investors can look forward to a 1.7% real return per annum.
What’s more, equities tend to be better long-term income investments because companies’ earnings rise with inflation. As a result, dividend payouts tend to rise at a rate that is equal to, or above, prices. In comparison, savings accounts only have to pay the Bank of England base rate (or less), which can remain unchanged for years.
Top income stock
Take one of the FTSE 100’s top income stocks, Imperial Brands for example.
This company has committed itself to 10% per annum dividend increases, taking the payout from 106p per share in 2012 to 171p for 2017, growth of around 61% in six years. Over the same period, the average interest rate available on cash ISAs has fallen. Imperial supports a dividend yield of 7.7% at the time of writing.
What about the risks?
If you are concerned that you may end up losing money by investing in the FTSE 100, let me draw your attention to these figures. Over the past few decades, even though there have been ups and downs along the way, the FTSE 100 has produced an average annual return of between 7% and 8%. And as your money is invested across the 100 largest companies in the UK, the chances of the index falling to zero, wiping out your entire investment are very slim indeed.
Put simply, buying a FTSE 100 tracker fund today could do wonders for your finances.
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Rupert Hargreaves owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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.