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Cash ISA savers are making just £12 per year. Here’s how I’d invest £5k today

The latest news is grim for cash savers. The Bank of England’s latest interest rate cut means that high street banks have slashed savings rates again. The average Cash ISA now pays interest of just £12 per year on a typical balance of £5,114, according to data from RateSetter.

Fortunately, there is another way. A Stocks and Shares ISA provides all the tax-free benefits of a Cash ISA. But it also gives you the chance to earn much bigger returns on your cash, as I’ll explain today.

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Cash ISA vs Stocks and Shares ISA

I’d always suggest keeping an emergency cash fund for life’s rainy days. But if you want to use your spare cash to build wealth, then I think using a Stocks & Shares ISA to invest in the stock market is a much better option.

The average high street cash ISA now pays just 0.24%, according to RateSetter.

But over the last 100 years, the UK stock market has generated an average return of about 8% each year. That’s equivalent to an annual gain of more than £400, based on the £5k ISA balance I mentioned above. I know which I’d prefer.

Buy now for the bounce

Give that the stock market crashed in March, you might think that a Cash ISA would be a safer place for your money. But I don’t think so. If you look back at the last 30 years, stock market crashes have always provided great buying opportunities for long-term investors.

When the market crashed on Black Friday in October 1987, the FTSE 100 had returned to its previous highs — a gain of 34% — by August 1989. Crashes in 2000 and 2008 were also followed by strong recoveries lasting several years.

Over the last few weeks, I’ve been buying FTSE 100 shares, which look cheap to me. To make sure that any profits and future dividends are protected from the taxman, all of these shares have gone into my Stocks and Shares ISA.

Stocks and Share ISA: essential facts

The Stocks and Shares ISA provides all the same tax-free benefits as a Cash ISA. You won’t ever have to pay capital gains tax or income tax on gains made in the account.

You can pay into one ISA of each type every year. So you can split your savings between a Cash ISA and a Stocks and Shares ISA, for example.

However, remember that the ISA contribution limit of £20,000 each year applies to your total ISA contributions. So the total you pay into both of your ISAs mustn’t be more than £20k.

How I’d get started

The tax year ends on 5 April, but you’ve still got time to open a Stocks and Shares ISA and deposit some cash. There’s no need to rush into any investments — once the cash is in your ISA, it’s protected from tax.

What would I buy with £5k today? What I’ve been doing is to spread the cash between good quality FTSE 100 dividend stocks, such as GlaxoSmithKline and Unilever. Over the long term, I expect companies such as these to continue to prosper and pay regular dividends.

Whatever you choose, I’d say one thing — the time to start is today. Investing over long periods is the most reliable way to beat the market and enjoy big gains.

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Roland Head owns shares of GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. 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.