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Forget the top Cash ISA rate. I’d buy FTSE 100 dividend stocks in an ISA today

Savers have experienced a hugely challenging decade. Interest rates declined to historic lows following the financial crisis, and have failed to offer a significant rise ever since. This has caused many savers to fail to generate an above-inflation return on their cash, which has reduced their spending power.

Looking ahead, interest rates could stay at low levels over the coming years. Risks such as Brexit and low inflation may mean that policymakers retain a loose monetary policy.

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As such, at a time when the FTSE 100 yields 4.4%, now could be the right moment to invest in large-cap dividend shares instead of relying on savings to generate a passive income.

Income potential

At the present time, it’s difficult to obtain an income return which is above 1.5% on your cash savings. By contrast, around a quarter of the FTSE 100’s members have dividend yields that are in excess of 5%. As such, it’s entirely feasible that an investor could build a portfolio of large-cap shares which, together, provides a dividend yield above 5%, or even in excess of 6%.

Furthermore, many of those companies are likely to increase their dividends in the coming years. The world economy is forecast to grow at an impressive rate in 2020 and beyond, while many large-cap shares have solid balance sheets and strong cash flows that can sustain an above-inflation rise in shareholder payouts. Therefore, the difference in returns available through FTSE 100 dividend stocks and cash savings could become more pronounced over the long run.

Growth prospects

Alongside their income potential, FTSE 100 dividend stocks also offer capital growth prospects. As mentioned, the FTSE 100 has a dividend yield of 4.4% at the present time. This is above its long-term average yield, and suggests the index offers good value for money. Alongside this, sectors such as banking and retail are relatively unpopular at the present time, and could present opportunities for investors to buy undervalued stocks.

The track record of the FTSE 100 shows that while it does experience challenging years, in the long run it has historically offered capital returns that are in excess of 5.5% on an annualised basis. As such, holding your shares over a long-term time period could mean that there’s a relatively high chance of them increasing in value.

Managing risk

Clearly, the risks attached to FTSE 100 shares are higher than for a Cash ISA at the present time. But, through identifying solid businesses with strong balance sheets, you may be able to avoid riskier stocks that could cut their dividends or fail to offer capital growth in the coming years. And, by diversifying across a range of companies, you can cut your risks even further so that the risk/reward opportunities within your portfolio are greater than for a Cash ISA.

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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.