I’ve just taken a look at the Cash ISA best buy tables, and they make grim reading. The best you can get with instant access is 1.46% a year. With inflation currently at 2.7%, that only guarantees the value of your money will fall in real terms.
You can get a higher return by locking your money away for between one and five years, but will still struggle to beat inflation. Two-year fixes typically pay around 1.60%, creeping up to 1.7% if you fix for three years, and 1.85% over five years.
All pay well below the inflation rate. Say you put £10,000 into a five-year fixed-rate Cash ISA paying 1.85% today, at the end of that term you’ll have £10,968. However, if inflation averaged 2.7% over the period, your money is only worth £9,565 in real terms.
Everybody needs some money in cash that they can get their hands on in an emergency, but your long-term wealth should go into stocks and shares as history shows they typically provide a superior return over the longer run.
Next year, for example, the UK’s benchmark FTSE 100 index is on course to yield a whopping 4.8%, roughly three times the return from the best instant access Cash ISA. Plus your capital may grow if markets rise (although it will shrink if they fall).
Dividend income thrashes bonds, where yields are tumbling. At time of writing, UK 10-year gilts yield just 0.45%, down from 1.26% at the start of the year, according to AJ Bell.
Investment director Russ Mould says this may may be one reason why the FTSE 100 is confounding the bears with a year-to-date gain of nearly 7% in capital terms, despite the prevailing political and economic uncertainty.
High yields can spell trouble
Brexit uncertainty looks set to drag on after so-called Super Saturday turned out sappy and soggy. However, this could offer a buying opportunity, as the index still looks undervalued.
The yield on a stock or index is calculated by dividing the company’s annual payout by its share price. So if the dividend is £1 and the stock trades at £20, the yield is 5%. When share prices fall, yields rise, so if that company’s share price falls to £10, the yield jumps to 10%.
As Mould points out, today’s generous dividend yields suggests the FTSE 100 is undervalued, because shares are “cheap and a lot of bad news may already be priced in.” That’s always a good time to buy, as you can benefit from any rebound.
Choose your stocks carefully
One word of warning. A super-high yield may be a sign of a company in trouble, as its share price has fallen sharply. For example, troubled BT Group currently yields 8.5%, but Royston Wild quickly found four reasons not to buy it.
That said, many high-yielders can also be attractive buys. Roland Head has picked out three FTSE 100 dividend stocks with 8%+ yields that he’d buy this month. Alternatively, you could spread your risk with an index tracker fund such as the iShares Core FTSE 100 ETF.
Provided you are investing for the longer term, shares look far more tempting than leaving your money to die a slow death in cash or bonds.
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Harvey Jones 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.