For a novice investor wondering which type of ISA is best for them, I’d suspect most would see a certain appeal to a Cash ISA, rather than a Stocks and Shares ISA. They might think that investing in the stock market is too complicated and risky. Keeping your money as cash and earning a steady interest rate has got to be safer than buying shares, right?
I’d question whether this line of thinking is accurate. My colleague, Rupert Hargreaves, notes that the best interest rate for an easy access Cash ISA is 1.46%, which is below inflation. For a long-term investor, I think this is dangerous.
It’s true: shares can lose money. That’s why I believe it’s important for investors to be well-informed and not to make any impulse purchases.
It’s also true that with a Cash ISA you won’t lose money due to market fluctuations. But if your investment is not keeping up with inflation, then the £10,000 you put in a Cash ISA will probably not have the same purchasing power today as it will in 20 years. This is where the risk comes in for this type of investment.
For an investor saving for a long-term goal, like retirement, I would think twice about keeping most of your assets in cash, as your loss could come from not keeping up with inflation.
We can work it out
People often fear that buying stocks is complicated. They hear the jargon and strange acronyms being spoken by bankers and CEOs. There is an easier way to invest in shares, and that is by putting money into an index fund.
An index fund will track its chosen market, with the aim to get close to its returns. These types of funds often charge very low fees. The beauty of passive investing in this way is that the complication is taken out of the mix.
Investors buying into an FTSE 100 index fund don’t necessarily need to worry about diversification, as the index already includes many different business sectors. Geographical diversification can be achieved from buying funds in different markets, such as the U.S. or emerging markets, for example.
Personal investors may fear a substantial drop in the stock market. But research shows that historically for periods of over 10 years, the FTSE 100 tends to outpace the rate of inflation. The market may hit a bump, and your holdings may go down, but it’s only a paper loss unless you cash out.
If we’re being realistic, a long-term investor will probably see the market take a significant drop at some point. There’s a risk of the market tumbling right after you make your investment. One way to mitigate this is by paying an amount into a fund at regularly recurring intervals.
So rather than losing money on your whole investment, the process of investing a similar amount month-on-month into your chosen fund should mean that you’re buying at the low, and sometimes high, price points, but averaging out in the long term.
Does cash have a place for any investor? I would argue that for short-term investing and savings, cash in an easily accessible account is a good place to have your money.
When it comes to investing for retirement, then I think that not keeping up with inflation could hurt.
T Sligo 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.