With all the chaos that’s been happening in the world and in the financial markets lately, it’s understandable that many people are worried about their savings and their retirement portfolios. Volatility can be frightening, especially for those people who hadn’t anticipated it. Accordingly, many might be wondering whether they might be better off simply putting their savings into a Cash ISA, rather than buying FTSE 100 shares. Read on to find out why that might not be such a good idea.
A losing proposition
Here’s the number one problem with holding cash in a long-term savings account: it’s the policy of virtually every Western government and central bank to have inflation averaging 2% annually. It’s also the current policy of almost every Western central bank to keep interest rates low. This seems unlikely to change significantly any time soon.
The US Federal Reserve and the Bank of England were both forced to cut interest rates (from already low levels) in response to the coronavirus pandemic. Currently, the Bank of England’s base rate (the benchmark interest rate that all other rates in the economy are based on) is just 0.1%. This explains why the very best rate that you can hope to get on a Cash ISA is around 1.65%.
So why would you accept a 1.65% annual rate of return on your cash when it’s the stated government policy to have the value of that cash decline by 2% due to inflation? Sure, the government might not be able to hit that target, but it seems like a bad idea to bet against it, particularly given how much financial power it has.
Stocks and Shares ISA
By contrast, the FTSE 100 has returned an average of 6.4% annually over the last 25 years, assuming reinvestment of all dividends. Investing £1,000 every year for 25 years at that rate would yield a total sum of almost £66,500. Now, of course there are some ups and downs within that period: the dotcom bubble over the early 2000s, the 2008 financial crisis, today’s coronavirus market crash — these are all periods of significant falls. But over the course of an investor’s lifetime, the data shows that investing in a Stocks and Shares ISA nets a better overall return than holding cash.
Moreover, the current depressed valuation of the FTSE 100 provides new investors with an excellent entry point to start building up their retirement wealth. This underlines another important factor in investing: you can’t time the ups and downs of the market, but you can determine when stocks are cheap, and when they’re expensive by looking at metrics to like price-to-earnings ratio, price-to-book ratio and dividend yield.
That’s how you plan for a future that’s not only dependent on a low State Pension. Buying cheaply and adopting a long-term perspective can reap rich rewards.
Neither Stepan nor The Motley Fool UK have a 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.