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Forget a Cash ISA! How I’d make a passive income with FTSE 100 shares yielding 4%+

With UK interest rates expected to remain significantly below their historic ‘norm’ of 4-5% over the coming years, now could be a good time to consider other means of generating a generous income.

After all, with inflation expected to be around 2% over the next year, Cash ISAs are losing money in real terms.

Since the FTSE 100 appears to offer a number of income opportunities, there are a variety of chances for investors to beat not only a Cash ISA’s income return of 1.5%, but also the index’s current 4.5% yield.

Low interest rates

Even though interest rates aren’t currently at an historic low, they’re close to it. Furthermore, the prospect of higher rates seems to be highly uncertain. Political and economic risks, such as the general election and Brexit, appear to be making the Bank of England’s interest rate decisions increasingly difficult to predict. As such, with inflation currently close to the 2% target, and the UK economy continuing to grow, the likelihood of rapid interest rate rises seems to be low.

This could mean Cash ISAs offer negative real-terms returns over the coming years. Ultimately, savers may live within their means and build a cash balance, only to find their spending power has been reduced.

High index yields

Due to the ongoing uncertainty in the world economy, the FTSE 100 offers a relatively high dividend yield. The current 4.5% income return of the index is around three times higher than the interest rates on a Cash ISA. Furthermore, it’s possible to obtain a portfolio yield of 5%, or even 6%, through buying the FTSE 100 stocks that have the most generous income returns as part of holding a diverse range of companies.

Looking ahead, the FTSE 100 also offers dividend growth potential. Since many of its members operate in fast-growing economies that include emerging markets in some cases, they may be able to produce rapid rises in shareholder payouts. Similarly, many FTSE 100 stocks have long track records of dividend growth, as well as significant headroom when making shareholder payouts. This could enhance their income appeal.

Changing strategy

As such, now could be the right time to focus your excess capital on FTSE 100 dividend shares, rather than a Cash ISA. Of course, having some cash available for emergencies is always a good idea. But the remainder can easily and relatively cheaply be used to purchase large-cap shares through an online sharedealing platform, such as a SIPP or a Stocks and Shares ISA.

Certainly, there may be additional risk of loss when purchasing FTSE 100 shares versus holding cash. But with the negative real-terms returns of cash likely to be present for some time, income investors may generate significantly higher returns from the FTSE 100 compared to a Cash ISA over the long run.

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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.