The Motley Fool

Cash ISA returns are peanuts. Here’s why I’d buy FTSE 100 dividend shares instead

With inflation standing at 2%, Cash ISAs offer negative returns on a real-terms basis. Even the very best Cash ISAs have returns of around 1.5%, which is 0.5 percentage points below the rate of inflation.

As such, having a range of FTSE 100 dividend stocks within a portfolio could be a shrewd move. Not only do they have the potential to deliver significantly higher income returns today, they may also be able to produce capital returns that improve your financial prospects in the long run.

Cash ISA returns

While Cash ISAs have been appealing in the past, the UK could face an extended period of low interest rates. At the present time, a return to the 4% to 5% interest rates that were viewed as ‘normal’ in the past seems to be many years away.

As such, savers face a continued loss of spending power that could leave them worse off in real terms over the long run.

Certainly, having a Cash ISA does not entail a risk of loss of capital. But the potential for a loss of spending power means that the product could have a negative impact on your financial position in the long run.

FTSE 100 income potential

Although the FTSE 100 carries a risk of loss, this can be mitigated to some degree through diversification. This reduces company-specific risk, which is the prospect of a stock delivering disappointing performance that then impacts on the wider portfolio. While market risk will always remain in place, which is the prospect of losses from the cyclicality of the wider stock market, in the long run the index has always recovered from downturns.

As such, an investor who is able to hold a range of stocks over a sustained period of time may be better off with FTSE 100 dividend stocks, rather than a Cash ISA. At the present time, the index yields 4.5%. However, it may be possible to build a portfolio that averages a return of 5% or even 6% if an investor focuses their capital on higher-yielding shares.

FTSE 100 growth outlook

Alongside its income prospects, the FTSE 100 could deliver impressive capital growth over the long term. Due to it being dependent on the world economy’s performance, it has the potential to benefit from the fast-paced growth that is on offer across a variety of emerging markets.

Furthermore, its yield suggests that it offers good value for money. This could attract investors to the index at a time when many of the world’s major indexes have posted high returns following a decade-long bull market.

While it may have delivered an annualised return of less than 1% over the last two decades, the index may now enjoy a period of improving capital growth. Alongside its impressive income return, it could be a better place to invest than a Cash ISA over the coming years.

Your 10 Step Guide To Making A Million In The Stock Market

A world-famous investor once said “Be greedy when others are fearful”. Here at The Motley Fool, we firmly believe that taking a different investing approach could also lead to significant potential gains for you. Get on the inside track today by reading our “10 Step Guide To Making A Million In The Market.” Click here to download for your FREE copy now.

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.