Cash ISAs continue to be significantly more popular than Stocks and Shares ISAs, with a larger number of the former being opened each year compared to the latter.
However, the returns available on a Cash ISA are much lower than for the FTSE 100. Furthermore, the tax benefits of having a Cash ISA have been diluted in recent years so that a savings account may be a better option for most people.
While risks are greater when investing in FTSE 100 shares versus a Cash ISA, in the long run the stock market has always recovered from its downturns to post higher highs. As such, now could be the right time to pivot from a Cash ISA to FTSE 100 shares.
Tax changes mean that the first £1,000 of interest income per year is now tax-free for many savers. This means that the previous tax advantages of having a Cash ISA versus a bog-standard savings account have disappeared.
Since interest rates are relatively low, the best savings rates are around 1.5% at present. This means an individual would need to have around £67,000 in savings in order to generate over £1,000 in interest a year.
Therefore, unless you have such a high amount of cash, there’s no benefit to having a Cash ISA versus a savings account. In other words, tax will not be payable on the interest received from either type of account – unless you have over £67,000 in a cash savings account.
Moreover, the tax benefits of investing in FTSE 100 shares could be significantly greater. The lead index, for example, yields over 4% at the present time. Since no tax is payable on capital held within a Stocks and Shares ISA, you can net a significantly higher sum of money from using your annual ISA allowance to purchase FTSE 100 shares.
The return prospects for the FTSE 100 continue to be relatively high. Since around two-thirds of the index is focused on international economies, it may benefit from the continued rapid growth rate of emerging economies.
The track record of the index shows it’s possible to generate high-single digit annualised total returns over the long run. In fact, since its inception in 1984, the FTSE 100 has recorded a total return of around 9% per year. Even though interest rates could rise and lead to improving returns on Cash ISAs in the coming years, they’re unlikely to deliver the same level of returns as the FTSE 100.
While investing in FTSE 100 shares is riskier than having a Cash ISA, the latter’s negative real-term returns mean the spending power of cash could fall over the long run. Therefore, there may not be a risk of capital loss with a Cash ISA, but over time it could lead to disappointment for savers who are aiming to build a retirement nest egg, or simply improve their financial standing.
The FTSE 100’s risks can be reduced through diversifying among a number of companies. This could also provide higher growth rates through accessing businesses that operate in a variety of regions and industries, thereby providing a more attractive risk/reward ratio versus a Cash ISA.
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