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Cash ISA versus the FTSE 100: Which should you choose?

When it comes to saving for the future, tens of thousands of savers open a Cash ISA every year. While there’s nothing wrong with opening a Cash ISA, even the best interest rates available on the market today don’t compensate savers for the risks they are taking by leaving their money in cash.

The biggest risk savers face

The biggest risk cash savers face is inflation. Inflation can make cash savings, which many savers believe are risk-free, exceptionally risky. Every year, inflation chips away at your wealth. And if you are not earning a rate of interest that’s greater than the rate of inflation, then your money is actually losing value.

According to my research, the best Cash ISA interest rate available on the market today is around 1.5% for an easy access product, or 2.3% if you are willing to lock your money away for five years.

By comparison, the annual inflation rate for the UK during the first quarter of 2019 averaged 1.9%, which implies money in a flexible Cash ISA receiving an interest rate of 1.5% will lose 0.4% of its purchasing power this year.

In my opinion, inflation risk is the primary reason why the FTSE 100 is currently a better investment than Cash ISAs.

Inflation protection

With a dividend yield of 4.4% at the time of writing, the FTSE 100 more than compensates investors for the risk of inflation. On top of this, company earnings tend to increase with inflation over the long term as businesses increase their prices. This means the capital value of the FTSE 100 should increase with inflation over time as well.

So that’s inflation dealt with. But what about the risk volatility? While it’s true the FTSE 100 does go up and down on a day-to-day basis, over the long term, the index has only gone up.

Between 1999 and the end of 2018, the FTSE 100 produced a total return of 93.5%, which I think is an awe-inspiring return considering the fact that this two-decade time frame contains not one but two severe bear markets, the bursting of the dot.com bubble and the financial crisis.

The very fact that the FTSE 100 almost doubled investors money during this time frame, which was one of the most turbulent periods for financial markets for some time, stands testament to its ability to create wealth over the long term.

The bottom line

There’s nothing wrong with putting a portion of your savings in a Cash ISA but, as I’ve explained above, even though the tax advantages of this product are attractive, the current interest rates available don’t make up for the risk of inflation.

With that in mind, I think the FTSE 100 is a much better place to invest your money today. What’s more, owning a FTSE 100 tracker fund inside a Stocks and Shares ISA will achieve the same tax benefits and a much better return on your money over the long term.

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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.