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Thinking of opening a Cash ISA? Here’s why I’d rather buy FTSE 100 stocks today

The popularity of Cash ISAs has remained high over recent years despite the paltry returns they offer. At the present time, for example, it is difficult to find a Cash ISA that pays more than 1.5% in interest per year without tying up your capital for an extended time period.

Looking ahead, interest rate rises are expected to be rather pedestrian over the coming years. When coupled with the fact that the first £1,000 in interest income from bog-standard savings accounts is tax-free, now may be a good time to avoid a Cash ISA and instead invest in FTSE 100 shares.

Disappointing prospects

As mentioned, the outlook for UK interest rates could mean there is continued disappointment ahead for savers. The Bank of England is expected to adopt a continued dovish monetary policy which means that interest rates are forecast to be little more than 1% in three years’ time. This could mean that the returns available on Cash ISAs continue to lag inflation, thereby reducing your spending power.

Furthermore, tax changes over recent years mean that the first £1,000 of interest received per year is not subject to income tax. As such, at a rate of 1.5%, you would need to have £67,000 in a Cash ISA to make it worthwhile from a tax perspective when compared to a standard savings account. And, with the interest rates on savings accounts being very similar to those of Cash ISAs, there seems to be little reason to have a Cash ISA for most people.

Improving outlook

By contrast, investing in a range of FTSE 100 shares could prove to be a worthwhile move at the present time. As ever, there are risks facing the index which are causing investors to adopt a cautious attitude towards a range of stocks. This could mean that there are buying opportunities for long-term investors who are able to capitalise on the cyclicality of the index.

For example, a number of FTSE 100-listed businesses that have operations in the UK currently trade on exceptionally low valuations. Among them are banks, housebuilders and retailers that while offering improving financial prospects over the coming years, currently trade on price-to-earnings (P/E) ratios that are significantly lower than their historic averages. This could mean that they offer wide margins of safety, and that there is scope for improving share price performances in the long run.

Cash flow

Of course, having some cash to hand is always a good idea. It provides peace of mind should it be required in an emergency. However, using up your annual ISA allowance through having a Cash ISA does not seem to be a logical move. Instead, having a savings account and investments in the FTSE 100 could produce higher returns that improve your financial outlook over the coming years.

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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.