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Forget a Cash ISA. I’d rather buy and hold FTSE 100 dividend stocks

The number of Cash ISAs opened each year continues to significantly outweigh subscriptions of Stocks and Shares ISAs. That’s surprising given that the best returns available on a Cash ISA currently stand at around 1.5%. This is lower than the rate of inflation, and means that the spending power of every £1 invested in a Cash ISA is falling each year.

By contrast, an investor can beat inflation through the income returns on FTSE 100 dividend shares. In fact, it’s possible to buy a diverse range of large-cap shares in order to obtain an income return of as much as three times the rate of inflation. As such, FTSE 100 income shares could be a better investment for the long term than a Cash ISA – even though there’s a greater risk of loss.

Risk/reward

Clearly, investing in a Cash ISA is a low-risk opportunity. Unless an individual has more than £85,000 invested in a single banking group, capital losses aren’t possible on a Cash ISA. While this may be appealing compared to investing in the FTSE 100 over the short run, in the long term the index has historically offered capital growth, rather than losses.

Certainly, the FTSE 100 has experienced major bear markets such as during the financial crisis, where it declined by around 50%. However, since it was created in 1984, it’s risen from 1,000 points to its current level of over 7,000 points. Over the next 25 years, further capital growth is likely as the profits of its constituents are set to rise as the world economy continues to grow.

Therefore, for individuals who have a long-term investment horizon, the volatility of the FTSE 100 may be a price worth paying for the income and capital growth potential it offers.

Dividend opportunities

While the FTSE 100 has made gains since the start of the year, its disappointing performance in the second half of 2018 means it may still offer good value for money. In fact, it yields over 4%. This is historically high, and suggests investors may be able to buy into the index at a point where it represents good value for money.

For investors who are seeking an even higher income return, there are stocks in the index that offer yields of as much as 8%+ at present. Although they may be relatively risky, they could offer the scope for impressive returns over the long run.

Long-term prospects

Of course, buying a diverse range of dividend shares is crucial in order to reduce company-specific risk. While the fluctuations of the stock market will remain even in a diversified portfolio of shares, exposure to the global economy through the FTSE 100 could provide a boost to an individual’s long-term financial prospects.

As such, buying dividend stocks instead of investing in a Cash ISA may lead to an improved risk/reward ratio over the long run that provides greater scope to retire early, or enjoy greater financial freedom in older age.

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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.