Cash ISAs continue to be hugely popular, despite interest rates being close to historic lows. This means that in many cases, savers are receiving an income return that is lower than inflation. Over time, this can lead to a loss of spending power.
As such, investing in FTSE 100 shares could be a better idea. Despite a strong performance in 2019, the index continues to offer a dividend yield that is above 4%. Through buying a diverse range of shares, you may be able to build a surprisingly large passive income that grows at a faster pace than inflation.
Cash ISA prospects
While interest rates are unlikely to stay at their current low level in the long run, their rise could prove to be painfully slow for savers. The UK’s economic outlook continues to be highly uncertain, and Brexit risks could be present throughout 2020. Alongside the prospect of low inflation, this may lead to the Bank of England deciding to keep interest rates at a low level. This would help to support the UK’s economic performance during what is a challenging period.
The end result of this could be further below-inflation returns for Cash ISA savers. In the long run, the loss of spending power could prove to be significant and may be detrimental to your retirement plans.
FTSE 100 prospects
Of course, the FTSE 100 is a riskier place to invest than holding cash in an ISA. The index currently faces numerous risks, such as geopolitical uncertainty in the Middle East and a global trade war, that could negatively impact on its performance.
However, the track record of the index shows that its members have offered high and growing dividends in many cases. Therefore, with the FTSE 100 offering a wide range of companies that are due to post improving levels of profitability in 2020 and beyond, now could be a good time to purchase stocks that offer dividend growth potential. In many cases, their low valuations suggest that they offer wide margins of safety that may factor in the risks facing the world economy.
Building a portfolio
Due to the risks involved in buying shares, it makes sense to diversify. This reduces your reliance on one or more companies, and may mean that a dividend cut or profit warning has a smaller impact on your overall returns versus a concentrated portfolio.
With it being easier and cheaper than ever to open a Stocks and Shares ISA, obtaining the FTSE 100’s 4.3% yield is increasingly accessible to almost anyone. Although buying shares can produce greater volatility than having a Cash ISA, in the long run it could have a far greater positive impact on your passive income and financial future. As such, now could be the right time to pivot from cash to shares.
Peter Stephens 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.
Motley Fool UK 2020