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Thinking of opening a cash ISA? Here’s why I think you could be set to make a huge mistake

The end of the tax year is rapidly approaching, and if you’ve not made the most of your ISA allowance for the 2018/19 year, then now is the time to do so.

However, if you are planning to open a cash ISA, I think you could be about to make a huge mistake. Today I’m going to explain why and suggest what you should do instead.

A big mistake

Cash ISAs can be a great savings tool. Any money you save in a cash ISA is safe from the taxman so if you have a lot of cash savings, then sheltering some of your money in the tax efficient cash ISA is a great idea — especially if you are a higher or additional rate taxpayer.

But I think cash ISAs should only be used as part of an overall wealth management strategy as, while the tax benefits of cash ISAs are attractive, they have two substantial drawbacks.

Lack of choice

First of all, they are relatively inflexible. If you open a cash ISA, you are relatively limited in what you can do with your money. Unlike a stocks and shares ISA, which lets you buy assets all over the world, including cash-like instruments such as government bonds, with a cash ISA you are stuck with whatever rate of interest the provider wants to give you.

For example, according to Money Saving Expert, Coventry Building Society currently offers an interest rate of 1.5% on its cash ISA with unlimited withdrawals — one of the best rates of interest on the market — but this includes a bonus rate of 0.35% up to 31 July 2020. After this, the rate is likely to drop to 1.15%.

If you are happy to lock your money away for a while, OakNorth is offering 1.78%, but once again, this product does not give consumers much choice. Once you’ve opened the account, you are locked in for a year.

Losses from inflation

The second reason why I believe opening a cash ISA could be a big mistake is because most cash ISAs on the market today do not offer a rate of interest that matches or exceeds inflation. With this being the case, any money invested will be eroded by inflation over time.

According to recently published research from wealth manager Brewin Dolphin, if investors had put £100 in a savings account in February 2009, today it would have purchasing power of just £84. In other words, having savings in a cash account has only cost investors money since the financial crisis.

On the other hand, the same research from Brewin Dolphin reveals that’s a similar £100 investment in the FTSE 100 in February 2009, would be worth £314 today, that’s including an annual fee of 0.5%.

These numbers clearly show how damaging cash ISAs can be for your wealth over time. In my opinion, it doesn’t make much sense to use a cash ISA, when it is only going to cost you money over the long term.

That’s why I believe you could be making a big mistake if you are planning on opening a cash ISA. Based on the figures above, a stocks and shares ISA could be the better option.

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Rupert Hargreaves owns no share 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.