The one big problem with trying to build a retirement pot using a Cash ISA is that the interest you receive is likely to be eroded by inflation. This means your savings aren’t really working very hard for you.
Moreover, when inflation is higher than interest rates, as it has been for most of the last decade, your savings aren’t working for you at all. In fact, the real value of your cash is actually falling. As such, relying on saving in a Cash ISA could prevent you from achieving your long-term financial aspirations.
Stocks, gilts and gold
Here at the Motley Fool, we believe that once you’ve built up a cash buffer for contingencies, investing in the stock market is the best way to increase your wealth, and enjoy a financially independent retirement. This is because, over long periods, stock markets have delivered returns that knock those of cash into a cocked hat.
However, stock markets can fall dramatically at times. Not everyone is comfortable with that, even though history shows markets have always bounced back, and gone on to new highs.
If you find the prospect of meagre returns on cash and the occasional plummet of the stock market equally unpalatable, it’s worth remembering you don’t have to go all-in on cash or stocks. In fact, there are other assets you could hold alongside cash and stocks that historically have tended to smooth returns.
For example, while the FTSE 100 (the index of the UK’s biggest 100 stocks, including the likes of Shell, HSBC and GlaxoSmithKline) crashed almost 50% in the great financial crisis a decade ago, gold and government bonds (gilts) posted double-digit gains. A person with his/her investment pot divided equally between cash, stocks, gold and gilts would have seen a relatively modest single-digit decline in their overall wealth during that tumultuous period.
ETFs in a Stocks and Shares ISA
In a Stocks and Shares ISA, you can hold not only stocks, but also gilts and gold, via what are called Exchange Traded Funds (ETFs). As an example, you could invest in the iShares Core FTSE 100 UCITS ETF, the iShares Core UK Gilts UCITS ETF and the iShares Physical Gold ETC.
The table below shows annual returns (including interest and dividends where applicable), for these three ETFs in each of the last five years. Along with cash at a nominal 1% interest rate. The average in the bottom row is the equivalent of the return you would have achieved with an equal holding of all four assets. The final column shows the total return over the five-year period.
Now, this short timeframe can’t be taken as representative of longer-term returns (for example, gilts have been particularly strong in the period). But it shows how combining different assets can provide a superior return to cash, with modest down years relative to — in this instance — a gold-only investor (in 2015) or a FTSE 100-only investor (in 2018).
If you’re in the happy position of having surplus cash each year to build a nest egg for later in life, it could well pay you to explore — with an independent financial adviser, if necessary — putting at least some of that cash into other assets, with a view to growing your wealth at a faster rate and enjoying a more prosperous retirement.
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G A Chester 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.