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No savings at 40? I’d avoid a Cash ISA and invest in FTSE 100 shares to retire early

Having no retirement savings at 40 does not necessarily mean that your chances of retiring early are severely reduced. However, investing your spare capital in a Cash ISA could be detrimental to your retirement plans. It offers a low rate of return that is unlikely to beat inflation over the long run. Therefore, it may not provide a positive real-terms return that boosts your retirement prospects.

By contrast, investing in the FTSE 100 could offer a favourable outlook over the long run. It has a solid track record of growth, while its current outlook suggests that now could be an opportune time to buy a range of large-cap dividend shares.

Cash ISA returns

At the present time, the best interest rates that are available on Cash ISAs are around 1.5% per annum. They are likely to remain at a relatively low level over the medium term, since the Bank of England is expected to maintain a dovish stance on interest rates. There is even a fair chance that the next interest rate move could be downwards, due in part to the risks posed by Brexit.

Over the long run, the interest rates that are available on Cash ISAs may continue to lag inflation. A key reason for this is that interest rate rises have historically been prompted by an increasing inflation rate, with policymakers generally seeking to cool rapid increases in the price level through adopting a more hawkish monetary policy.

Therefore, even if interest rates move higher, they may still lag inflation. Ultimately, this will mean that your spending power declines over the long run, which could produce a disappointing income return in retirement.

FTSE 100 potential

The returns on the FTSE 100 have historically been significantly higher than those on cash. This trend is likely to continue over the long run, with the index offering a range of undervalued investment opportunities at the present time. Many of these opportunities have been caused by weak investor sentiment following a period of uncertainty for the world economy. This has produced an increasingly risk-averse attitude among investors, which may lead to buying opportunities.

Certainly, there is a risk of paper losses in the short run. The FTSE 100 has enjoyed a decade-long bull market that will not last forever. However, an investor who is aged 40 – or who has a long-term horizon before intending to retire – is likely to have sufficient time for investments to recover from future bear markets. In other words, the volatility of the FTSE 100 should not be a cause for major concern, since in the long run it is likely to produce high returns that boost your retirement prospects.

As such, now could be the right time to pivot from a Cash ISA to FTSE 100 shares. It could lead to an earlier retirement age, or a higher income in older age.

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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.