The Motley Fool

Cash ISA returns are still negative. Here’s where I’d invest my money instead

With around 80% of all ISAs being cash ISAs, it’s clear they remain a very popular product among consumers. Individuals may find them a simple way of saving for the future as there’s no tax paid on interest income.

Their popularity, though, is somewhat surprising. After all, they offer a negative return when inflation is factored in, while their tax advantages are becoming increasingly limited. As such, avoiding them could be a shrewd move, with a Stocks and Shares ISA potentially offering a more enticing risk/reward ratio for the long run.

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Negative returns

With the best interest rates currently on offer within a Cash ISA being 1.5%, investors are losing money each year on an inflation-adjusted basis. This means that, with inflation being 1.9% at the present time, every £1 invested in a cash ISA offers reduced purchasing power in future. While this may not be noticeable over a period of months, over the coming years it could mean that savings held here become less effective for the purpose they were intended.

Furthermore, interest rate rises are not expected to be brisk over the coming years. The Bank of England may be cautious about raising rates too quickly. This may mean that the return on cash ISAs continues to lag inflation, with the gap between them having the potential to increase should there be a weakening of the pound as the Brexit process moves ahead.

Better option

From a tax perspective, there’s also little incentive to use a cash ISA. With interest rates so low, and the first £1,000 of interest income earned by an individual each year not subject to tax, a cash ISA would need to amount to £67,000 in order to provide any tax benefit at the present time.

In contrast, a Stocks and Shares ISA could help an individual who invests even a modest sum of money in shares to avoid dividend tax and capital gains tax. The former has become increasingly onerous in recent years, and could continue to be so over the medium term. As such, when it comes to planning for retirement and the potential to have a sizeable nest egg in place, maximising tax savings through a Stocks and Shares ISA could be worthwhile.

In terms of the potential for the stock market to beat inflation on a regular basis, this seems to be highly likely. Certainly, there may be years where even a cash ISA beats the return of the FTSE 100. But over the long run, the index’s 4%+ dividend yield and capital return potential should mean that it’s the more appealing option for investors who don’t require immediate access to their capital. Therefore, while cash ISAs remain popular, they appear to lack investment appeal relative to other assets.

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