The UK inflation rate dropped to just 0.5% in May, and it could go even lower. I’d even say there’s a possibility of deflation, which would be a very rare phenomenon. In a low-inflation economic environment, should you invest in a Cash ISA? I’m going to explain why I think that’s a bad idea, and why the time is ripe for investing in FTSE 100 shares instead.
Cash ISA rates falling
With UK base rates super low too, the best interest you can hope to get from a standard instant access Cash ISA right now is around 0.9%. You can do better if you tie your cash up for a fixed period. But you’re looking at a five-year commitment to earn just 1.2% per year.
My usual complaint about a Cash ISA rather than FTSE 100 shares is that interest rates have been below inflation. Ironically, inflation dropping to 0.5% means today’s Cash ISA rates are actually positive in real terms. But that’s almost certainly not going to last.
That 0.5% inflation rate is clearly an anomaly, a result of the Covid-19 lockdown. But as we see the lockdown increasingly eased, economic activity will improve. And even if inflation should dip even lower in the short term, it will surely get back to its long-term levels before too long. In fact, the Bank of England is tasked with achieving exactly that.
FTSE 100 shares doing worse
Even if current interest rates are unattractive, a top Cash ISAs will have easily beaten FTSE 100 shares so far this year. Right now, the FTSE 100 is sitting on a loss of around 17% since the start of 2020. Usually, when share prices dip, we still have dividends to keep us going. But many companies have slashed their dividends too.
So why do I recommend a Stocks & Shares ISA, invested in FTSE 100 companies, ahead of a Cash ISA? And why especially right now when Cash ISAs are winning?
To explain why, I’m going to look back at what happens after stock market crashes. This year’s lockdown-triggered crash took the FTSE down below 5,000 points. But since that low, it’s climbed by 25%.
The previous low was back in February 2016, and in the following 12 months the FTSE 100 climbed by 32%. Looking further back to the banking crisis, the FTSE 100 bottomed out in March 2009. Over the next 12 months, the index rose by 57%. Those are all big gains that Cash ISA investors would have missed.
Incidentally, FTSE 100 shares are now 80% higher than that 2009 low. And we’ve had a decade of dividends too, which will take it well above a doubling. Over that timescale, that’s poor by FTSE 100 standards. But it still wipes the floor with a decade of Cash ISA interest.
FTSE 100 shares vs Cash ISA
That last bit is what really matters, that FTSE 100 shares beat a Cash ISA over the long term. I reckon they have to really, as companies are the only things that generate actual new wealth. And there’s really nowhere else a Cash ISA can ultimately get money from to pay its watered-down interest.
And it really does look like moving to the apparent safety of a Cash ISA from FTSE 100 shares during times of stock market crisis is the exact opposite of the best move.
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Views expressed 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.