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Warning! A Cash ISA could damage your wealth. I’d buy the FTSE 100 instead

The safety of cash can be seductive. It’s like a comfort blanket. And I agree that it’s important to keep cash on hand to pay for emergencies and major spending such as holidays.

But if you think that saving in cash will help to make you richer or fund your retirement, I think you’re likely to be disappointed.

Today’s world of ultra-low interest rates means that earning 1.5% on a cash ISA is about as good as it gets. At that rate, it would take about 48 years for your cash to double in value.

It gets worse

That’s bad enough. After all, I suspect most of you reading this hope to retire in less than 48 years.

But as my father-in-law pointed out recently, the longer you keep cash in the bank, the less it’s worth. That’s because of inflation, otherwise known as the rising cost of living.

Depending on which measure you choose, UK inflation is currently running at between 2% and 2.8%.

With inflation at 2%, it will take 36 years for the cost of living to double.

With inflation at 2.8%, it will take just 26 years.

In either case, we can see that our Cash ISA savings will buy less in the future than they do today.

It seems clear to me that saving in cash is not a suitable way to build retirement wealth. So what should we do instead?

Are you missing out?

A recent survey found that just 2.2m people in the UK have subscribed to a Stocks and Shares ISA this year. That suggests that millions of us are missing out on a useful and tax-free way to make our spare cash work harder.

According to Barclays, the long-term average return from the UK stock market is 8% per year. In my view, investing some spare cash in stocks and shares is a no-brainer if you’re trying to build up your retirement savings.

Although the value of your investments can fall as well as rise, in my experience the stock market isn’t as risky as it’s made out to be. Put your cash into a FTSE 100 tracker fund and you’ll avoid the kind of speculative, fly-by-night stocks that give investing a bad name.

Instead, you’ll own shares in a diversified group of larger, well-established companies. These have usually been in business for many years and tend to have reliable profits. Examples include Tesco, Unilever, Royal Dutch Shell, Vodafone and pharmaceutical group GlaxoSmithKline. I own shares in several of these firms myself.

Start from £25 per month

At the time of writing, the FTSE 100 offers a dividend yield of 4.6%. By investing in a FTSE 100 tracker fund you’ll receive this income each year plus any gains (or falls) in the value of the index.

Most tracker funds allow monthly payments from as little as £25, so you don’t have to make a big commitment upfront. Hold your fund in a Stocks and Shares ISA and all future capital gains and income will be tax-free.

You can still subscribe to a Cash ISA in the same year as well, if you’d like. The rules allow you to subscribe to one of each type of ISA each year, as long as your total contributions stay within the annual limit of £20,000.

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Roland Head owns shares of GlaxoSmithKline, Royal Dutch Shell B, and Tesco. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. The Motley Fool UK has recommended Barclays and Tesco. 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.