After the Bank of England decided to slash interest rates last month, Cash ISA providers have rushed to follow suit. The highest flexible Cash ISA interest rate on the market at the moment is just 1.25%.
If you are willing to lock your money up for a year or more, you can earn a better return, but not by much.
The best one-year fixed Cash ISA offers an interest rate of just 1.35%. The best two-year Cash ISA provides a rate of 1.46%.
With this being the case, if you are looking for a better return on your money, buying the FTSE 100 might be a better option.
Cash ISA alternative
The most significant benefit of opening a Cash ISA is its tax benefits. You never have to pay tax on income or capital gains earned on money held in an ISA. But that applies to Stocks and Shares ISAs too.
However, the one primary drawback of using a Cash ISA over a Stocks and Shares ISA is a lack of flexibility.
With a Cash ISA, you have to accept the interest rate offered by the ISA provider. With a Stocks and Shares ISA, you can shop around for better investments. In fact, you can own any investment as long as it is traded on a “recognised exchange.” That essentially means any stock or bond that’s traded on a developed market stock exchange.
Having said that, picking stocks can be a challenging process. Even the professionals get it wrong regularly. Therefore, a better strategy might be to own the entire market.
Indeed, investors who were savvy enough to buy a FTSE 100 tracker fund at the height of the financial crisis saw a return of 9% per annum on their money to the beginning of March.
The other benefit the UK’s leading stock index offers is income. Even after the tidal wave of recent dividend cut announcements, the index still offers a dividend yield that’s more than double the 1.25% interest rate on the best Cash ISA on the market right now.
When companies resume their cash return plans, it’s likely the index’s yield will rise significantly from current levels.
The bottom line
So overall, while owning a Cash ISA might seem like a safe option in the current market, from a long-term perspective, it might be a big financial mistake. Because inflation has averaged 2% per annum for the past few decades, a return of 1.25%, suggests that your money will earn a negative real interest rate. That implies your money will lose purchasing power over the long run.
With this being the case, if you are serious about saving for the future, it could be best to look past the market’s near-term volatility and concentrate on the long-term wealth-creating power of the FTSE 100.
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Rupert Hargreaves 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.