Investing in FTSE 100 shares could prove to be a better idea than having a Cash ISA in 2020. Interest rates are currently close to historic lows, while the pace at which they are likely to rise in the coming years could prove to be relatively slow.
By contrast, the FTSE 100 could deliver high returns. Many of its members trade on low valuations and offer high dividend yields. This could lead to improving total returns that boost your long-term financial prospects. As such, focusing your capital on large-cap shares, rather than cash savings, could be a good idea.
Low cash returns
Cash ISAs have proved to be a simple and effective means of building a cash balance in previous years. However, a low interest rate that is unlikely to move significantly higher due to a modest rate of inflation and economic uncertainty in the UK may mean that Cash ISA returns are low.
Furthermore, the tax advantages of a Cash ISA are highly limited at the present time. Assuming an interest rate of 1.5% on the capital held in a Cash ISA would mean that you would require a balance of over £67,000 to obtain tax benefits versus a bog-standard savings account. This is because the first £1,000 in interest received from savings accounts each year is not subject to tax for basic rate taxpayers.
Therefore, rather than using up your annual ISA allowance of £20,000 on a Cash ISA, it may be a better idea to invest instead in FTSE 100 shares through a Stocks and Shares ISA.
Improving FTSE 100 potential
The FTSE 100 may have experienced a decade-long bull market, but the index still seems to offer good value for money. Sectors such as banking, retail, financial services, industrials and healthcare offer low valuations and improving growth prospects, with a number of their members seeming to have a potent mix of rising dividends and wide margins of safety.
Furthermore, with the index being focused on international markets, it offers geographic diversity that helps to reduce risk. This also provides investors with access to the high growth potential of emerging economies, which could offer improving financial rewards in the coming years.
Through diversifying across a range of FTSE 100 shares, it may be possible to reduce your risk of loss. Diversifying reduces company-specific risk. It means one company’s weak financial performance would affect your portfolio to a lesser degree when there are a number of other stocks held alongside it. As such, with the cost of buying and selling shares being cheap, it makes sense to own a range of companies that operate in a variety of different sectors.
Of course, holding some cash in case of emergency is always a good idea. However, focusing the majority of your capital on a Cash ISA, rather than buying FTSE 100 shares, may not be a rewarding experience – especially with large-cap stocks appearing to offer favourable risk/reward ratios.
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.