Every year, millions of Britons put money into a Cash ISA, but I wonder whether they really know what they’re doing.
While it’s important to hold some cash for a rainy day, you can’t afford to leave too much money sitting idle. These days, you’re lucky to get more than 1% on instant access, which means the value of your money is falling in real terms.
Once you’ve built a pot of emergency cash, you need to put your longer-term savings to work to generate a higher return. I think the best way of doing this is to invest in the stock market, either through a fund or individual FTSE 100 stocks.
One of the most attractive on the index right now is Lloyds Banking Group (LSE: LLOY). Before the financial crisis, the high street bank was described as a ‘dividend machine’ because it regularly lavished investors with generous dividends. Millions used it to boost their income in retirement, and it remains one of the most traded stocks in the UK today.
On the mend
Lloyds has spent the last decade cleaning up its act after misdemeanours during the financial crisis, turning itself into a leaner, meaner operation, cutting jobs and closing branches. It has narrowed its focus on the domestic UK economy, providing loans to small businesses, and savings, mortgages and credit cards to consumers.
This should make it lower risk, although it does leave it exposed to the fortunes of the UK economy, which is one reason why the Lloyds share price struggled to grow during the political and economic uncertainty surrounding Brexit.
Lloyds has worked hard to restore its dividend, which is the real attraction of investing in the stock. Right now, it’s forecast to give you income of 6.2% a year, which is five or six times the return you’ll get on an instant access Cash ISA.
Another attraction of dividend stocks over cash is that they aim to increase their payouts over time, which allows you to lock into a rising income. Next year, for example, Lloyds is expected to yield 6.4%. No savings account can match that. If its share price recovers, you’ll get capital growth on top, free of tax, in a Stocks and Shares ISA.
Investing in shares is more risky than leaving money in cash. You should be looking to invest for a minimum five years, but preferably much longer. I think Lloyds makes a strong ‘buy and hold’ case with shares you can hang onto for decades, all the way to retirement. Keep reinvesting the dividends for growth and then you can take the proceeds as a passive income after you stop working.
Lloyds isn’t perfect. If the UK economy stumbles, its share price will struggle. However, given that it trades at a bargain valuation of just 8.4 times forward earnings, you have a large safety net if that happens. Today’s low share price could be a good opportunity to buy it on the cheap. I’d pick it over a Cash ISA any day.
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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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.