One of the features of the extraordinarily low base interest rate environment we’ve seen since last decade’s credit crunch has been the death of the cash ISA account. They still exist, of course, but they’re worse than useless. That’s because the derisory interest rates they’ve been paying guarantee that if you ‘invest’ in one you will lose some of the spending power of your money over the holding period.
Why saving cash is an anti-investment
Putting money in a cash ISA savings account today is like making an anti-investment. The best cash ISA interest rate that the MoneySuperMarket comparison website could find for me most recently was 1.38% annual equivalent rate (AER). Pathetic! Annual inflation is running at about 2.7%, so even with my money in a top-paying cash ISA, I’d be losing around 1.32% a year of my spending power.
However, there’s another opportunity to save money in a bank account. The market has turned itself upside down over the past decade or so and now, according to MoneySuperMarket, some current accounts offer much higher rates of interest than even the best-paying easy access savings accounts, “and, of course, still offer immediate access to your money.” TheCompareTheMarket comparison website found me a Nationwide current account paying 5% AER and a Tesco one paying 3% APR. You’ll need to read the terms and conditions to discover how to qualify for those rates and, in each case, there’s a limit to how much you can save and still earn the higher interest rate. If you save more, the additional money reverts to earning a derisory interest rate.
There are also other types of savings accounts on the market, such as savings bonds, where you tie up your money for a given period to earn the interest. But I couldn’t find one of those paying more than about 3%. Overall, the market for bank accounts that pay you interest looks dire, and I’d invest my money elsewhere.
The best-performing class of asset
Instead of investing in a cash ISA, I’d go for a stocks and shares ISA. Studies have shown that over the long haul, the total return from shares has outpaced the return from all the other major classes of asset, such as property, bonds and cash savings.
And a big part of the total return investors enjoy from shares is from the dividends that the underlying companies pay. Just look at some of the biggest firms listed on the London stock market right now. BP is paying a dividend yielding 6%, GlaxoSmithKline’s is 5% and HSBC Holdings is 5.6%.
One popular strategy is to buy shares in high-yielding companies in order to harvest the dividend, which you can then reinvest into shares again with the aim of compounding your money. However, I think that investing in a low-cost, FTSE 100 tracker fund that automatically reinvests dividends for you is an attractive, low-hassle alternative.
If you invest in a fund that mimics the performance of the FTSE 100 you will be neutralising the single-company risks that come with investing in just a few shares. Most funds give you the option to invest regularly, such as once a month, and if you hold the investment in a stocks and shares ISA wrapper, all your gains will be free of tax.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended HSBC Holdings. 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.