Saving in cash is easy, quick, and familiar. Plus it’s free. Cash ISAs don’t have platform fees, management charges, or dealing costs – unlike most Stocks and Shares ISAs.
If you’ve got £1,000 to spare and would like to invest this money, a Cash ISA might seem like a sensible choice.
After all, your money should be protected up to the FSCS compensation limit of £85,000. And you’ll receive a cash interest payment each year.
The only problem with this is that despite appearances, you may be losing money. Let me explain.
Don’t ignore inflation
At the time of writing, the best cash ISA interest rate I could find for an instant access account was 1.46%.
In August, the official Consumer Price Index measure of inflation in the UK was 1.7%. This means that the cost of living is rising at 1.7% per year.
I’m sure you can spot the problem here. If your Cash ISA is paying 1.46% each year, but the cost of living rises by 1.7%, then the real value of your money has fallen.
You still need cash
Despite the impact of low interest rates, I think cash savings are very important. I believe everyone should try to build a cash emergency fund to meet unexpected costs such as car repairs, boiler breakdowns, and all the other nasty surprises of everyday life.
In my view, a good target is to keep three months’ income saved in cash.
This isn’t a fixed rule – the important point is to avoid having to borrow money to meet short-term expenses. The interest you’ll pay on a credit card or payday loan will be much higher than anything you’re likely to earn from the stock market.
Getting started with the stock market
If you’ve already set aside some cash for a rainy day, then you might want to consider investing any further spare cash in the stock market.
This won’t be suitable for everyone. Over short periods, the stock market can rise and fall unpredictably. I’d only invest cash I didn’t need for at least five years. Even then, there’s a risk that you won’t get back your original investment.
However, over longer periods, the stock market tends to outperform cash savings. According to figures produced by Barclays, the UK stock market has delivered an average annual return of about 8% over the last 100 years.
The simplest and cheapest way to start investing in the stock market is to invest some of your spare cash in a FTSE 100 tracker fund, inside a Stocks and Shares ISA.
By using a Stocks and Shares ISA, you can make sure that any future income and capital gains are tax free. By investing in the FTSE 100 you can benefit from the growth of some of the UK’s biggest companies – names such as BP, Tesco, and ITV.
At the time of writing, the FTSE 100 offers a dividend yield – similar to a variable interest rate – of about 4.5%. In addition to this, you will benefit if the value of the index rises.
Most of my spare cash is invested in the stock market. Over the long term, I’m confident it will outperform any cash savings. However, it’s a personal decision that won’t be right for everyone, so make sure you’re comfortable with the risks before you start.
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Roland Head owns shares of ITV and Tesco. The Motley Fool UK has recommended ITV 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.