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Why I wouldn’t bother with a cash ISA after the FTSE 100’s recent stock market crash

With interest rates expected to increase over the next few years, the pressure which savers have felt could begin to ease. Of course, there is no guarantee that this will take place, with Brexit offering a potential ‘curveball’ when it comes to future interest rate rises. But after a decade of pain, the interest income on cash is forecast to improve.

Of course, one way of boosting cash returns has been through opening a cash ISA. It is now possible to obtain 1.5% from a cash ISA, which is significantly higher than the 0.6% average return on a savings account. However, on a relative basis, even a 1.5% return is relatively low. The FTSE 100’s recent fall means that it offers three times that amount in dividends per year, and could therefore deliver significant outperformance of cash ISAs in the long run.

Risk/reward

Clearly, the FTSE 100 is riskier than a cash ISA. While the latter does not come with the potential for any capital loss (provided the amount invested is within the regulatory compensation scheme), the former could exhibit increasing volatility in future. After a decade-long bull market, the FTSE 100 has experienced a sharp decline since May, and this trend may continue in future. As such, there is a real risk of capital loss which may mean that the 4.5% dividend yield on offer is wiped out in a relatively short space of time.

Countering this risk, though, is the potential return which is on offer. The FTSE 100 has historically always recovered from its downturns, and has been able to generate a total return which is in the high-single-digits on an annualised basis. Therefore, for investors who are able to tie-up their cash for a number of years, it could offer a significantly better risk/reward opportunity than a cash ISA. Although there may be periods of paper losses in the medium term, in the long run it is likely that even a rising interest rate would not allow a cash ISA to deliver higher returns than the FTSE 100 in the long run.

Accessibility

One reason for the popularity of cash ISAs has been their accessibility. It is straightforward for anyone to open one, with it being very similar to opening a savings account. The process of paying money in and out is straightforward, and the returns are simply added to the account each year.

Investing in the FTSE 100, though, is no more challenging than opening a cash ISA. Products such as a Lifetime ISA or a stocks and shares one are straightforward to open, with purchasing shares being as easy as a couple of clicks online. And with dealing charges having fallen in recent years, it is possible for small investors to gain access to the FTSE 100. As a result, the appeal of the FTSE 100 versus a cash ISA seems to be increasing.

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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.