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Have all your savings in a Cash ISA? That could be a terrible mistake

Cash ISAs remain extremely popular with UK savers. At the end of the 2017/2018 financial year, around £268bn was held in them. That’s a lot of money. Is it sensible to keep all your savings in a Cash ISA though? Probably not, in my view.

Short-term vs long-term savings

Having some money in a Cash ISA, or a cash savings account, is a good idea. Cash plays a vital role in any financial strategy as it’s useful for short-term spending needs and can provide protection against unexpected expenses. You can access your money at any time with a Cash ISA, so this type of account is ideal for short-term savings, or for an emergency fund.

However, when it comes to money that you’re putting away for the long term, a Cash ISA has little appeal. That’s because with interest rates so low, any money sitting in a Cash ISA is actually likely to lose value in real-life spending terms over time due to inflation.

Inflation: the Cash ISA enemy

Inflation refers to the gentle increase in the cost of goods and services over time. You don’t notice it on a day-to-day basis. Yet, over time, it can add up significantly. Remember when a can of soft drink cost 50p at your local shop a few years back? Today, you’re probably looking at 70p or more for the same can. That’s inflation for you.

Inflation is currently running at around 2% per year, meaning that, on average, the prices of goods and services are getting 2% more expensive every year. However, looking at Cash ISA interest rates, the best you can obtain at the moment is around 1.5%.

What this means is that even if you’re picking up the best Cash ISA rate and earning 1.5% on your savings, your money is still actually going backward in real-life spending terms. Keep all your savings in a Cash ISA for 10 or 20 years, and you could find that down the track, that money actually buys you a whole lot less than you thought it would.

Grow your money

If you want your money to grow at a healthy rate and outpace inflation, the key is to put some of it in growth assets such as shares. Shares are riskier than cash savings as they constantly fluctuate in value. However, over the long run, shares tend to rise in value and produce returns of around 7-10% per year – a rate significantly above inflation.

Consider this ISA

One of the easiest ways to invest in shares is through a Stocks & Shares ISA as this offers a number of ways to invest in the asset class. For example, through a Stocks & Shares ISA, you could buy a FTSE 100 tracker fund, which simply tracks the performance of the 100 largest companies in the UK. Or you could buy an investment fund, such as the Fundsmith Equity fund, which has returned nearly 170% over the last five years.

Alternatively, if you’re willing to do a little bit of research, you could potentially pick stocks yourself. You have a lot of flexibility with a Stocks & Shares ISA.

The key takeaway here, however, is that while cash has its uses, it’s not a good long-term investment. Money sitting in a Cash ISA is likely to lose value over time.

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Edward Sheldon has a position in the Fundsmith Equity fund. 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.