Savers are likely to experience continued challenges when it comes to generating an income that is higher than inflation. UK interest rates may have been at historic lows for around a decade, but the speed at which they will rise in the coming years could prove to be frustratingly slow.
As such, pivoting from a Cash ISA to FTSE 100 dividend stocks could prove to be a shrewd move. Not only is it possible to obtain an income return that is three or four times higher than that offered by a Cash ISA, the scope for dividend growth means that the total income return on offer could be exceptionally high.
With the FTSE 100 having recorded an uncertain period of late, now could be a good time to buy large-cap income shares while they offer wide margins of safety.
Low cash returns
While interest rates have been significantly higher in the past than they are today, the income returns offered by Cash ISAs have historically been disappointing when compared to inflation. Since a higher rate of inflation is often a prompt for policymakers to adopt an increasingly restrictive monetary policy, Cash ISA returns have often proved to be modest on a real-terms basis.
Looking ahead, this could continue to be the case. With the UK economy facing an uncertain period, there is no guarantee that interest rates will return to normal levels of 4%-5% over the coming years. In fact, an interest rate cut could be the next move by the Bank of England as global growth risks remain in play.
By contrast, the FTSE 100 has a strong track record of producing impressive income returns. Its dividend yield of over 4% is around twice the rate of inflation, and could therefore offer a higher real-terms return than Cash ISAs over the long run.
In addition, the prospect of dividend growth means that income shares may become increasingly attractive over the long run. A number of FTSE 100 shares are expected to deliver inflation-beating dividend growth over the next couple of years, with their dividend coverage ratios and balance sheets suggesting that there is scope for this trend to continue over the long term. This could further extend the difference in income returns between Cash ISAs and dividend stocks.
While income investors may not list the prospect of capital growth as a priority, the FTSE 100 may offer good value for money at the present time. This could lead to an increasing portfolio value for investors over the long run that ultimately makes it easier to generate a generous passive income.
As such, now could be the right time to switch from a Cash ISA to FTSE 100 dividend stocks. Their higher returns, dividend growth potential and capital return prospects make them a more favourable investment on a risk/reward basis.
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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.