I remember the days when it was just about worth taking out a Cash ISA. If I cast my mind far enough back, I can vaguely remember getting interest rates of 5% or 6%, possibly even 7%. That’s right, on cash.
It seems unthinkable now, given that the max you can get today is 1.4% on instant access, and you know that won’t last long, because the bank is only using it as a teaser rate to drum up business. That’s why I would recommend investing in a Stocks and Shares ISA instead, as this gives you access to the greater growth potential of the stock market.
Too many people still hold legacy Cash ISAs, taken out in the days when people believed that ‘cash is king’, a statement that simply doesn’t hold true any longer. Many could have tens of thousands of pounds sitting in there, wasting away.
Cash doesn’t cut it anymore
While everybody needs a bit of cash for emergencies, you do not want to leave your long-term savings on deposit. That could prove disastrous for your retirement, as cash won’t generate the growth you need to build a big enough nest egg to retire on comfortably.
Too many people remain wedded to the concept of the Cash ISA, because it seems safe. The stock market scares them, because it is more volatile. However, the only guarantee that cash gives you is that the value of your money will erode in real terms, as it falls behind inflation.
Inflation has fallen lately, halving from 3.1% to 1.5% in the last couple of years, but that is still more than you will get on almost every cash account. By contrast, history shows that equities have delivered an average long-term total return of 7% a year, with dividends invested, not just protecting the value of your money in real terms, but boosting it.
Invest your money to grow
Talking of dividends, that is another way shares are superior to cash. Currently, the FTSE All-Share delivers an average yield of 4.24% a year, which is three times the rate on a best buy Cash ISA. Over the last five years, the index has delivered a total return of 35.6%. That would have turned £10,000 into £13,560. The FTSE 250 index has done even better, turning £10,000 into £14,890.
By contrast, the average savings account paid just 0.5%, which would have turned £10,000 into just £10,252, an astonishing £3,308 less than the FTSE All-Share and a hefty £4,638 less than the FTSE 250.
However, it is over the longer run that shares really score. If your £10,000 generates 7% a year growth over 40 years, you will end up with a quite incredible £149,745. If it gets an average return of, say, 2% a year in the bank, you will have just £22,080.
That is a huge difference. How huge? I’d say the difference between a happy retirement, and an unhappy one. So watch out for cash. It can do more harm than good.
Harvey Jones 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.