At the present time, investing in the stock market seems to be a bit of a gamble. After all, the FTSE 100 has declined by around 13% in the last eight months, and the prospects for the world economy are uncertain. In the near term, there could be further uncertainty that contributes to an even worse performance.
As a result, many individuals may be considering the benefits of a cash ISA. It offers significantly lower risk than the stock market, and has outperformed the FTSE 100 since May 2018. However, over the long run, it may prove to be highly unrewarding when compared to a Lifetime ISA, or a SIPP.
Track records
Over a long-term timeframe, the performance of shares held in a SIPP or a Lifetime ISA is likely to be significantly ahead of a cash ISA. In fact, at the present time a cash ISA offers a return of around 1.5% at best. Over a 10-year timeframe this means that £100 invested today will be worth around £116 in a decade. In contrast, the FTSE 100 has generated an annual total return of around 7% over the long run. Assuming £100 is invested in a diverse range of FTSE 100 shares, it could be worth as much as £197 in a decade.
Clearly, there is scope for the interest rate on cash ISAs to increase over the coming years. The market is anticipating this to happen, although the pace of increase is subject to how the UK economy performs following Brexit. As such, while there’s no guarantee of 7% annual returns from the stock market, a cash ISA may be unable to offer returns that are significantly above 1.5% per year over the long term.
Practicalities
While SIPPs and Lifetime ISAs may seem to be out of reach for many individuals, due to their perceived higher costs, this is no longer the case. The internet has caused costs for a variety of financial products to decline, and this means investors with more limited capital could obtain high returns even after costs are deducted. And with it being possible to open a Lifetime ISA or a SIPP online in a very short space of time, investing is far less time consuming than it was in the past.
Furthermore, contributions to SIPPs are not subject to income tax. This means that investors are essentially rewarded for investing through a SIPP. Similarly, the government pays investors a 25% bonus of up to £1,000 per year for contributing to a Lifetime ISA. In contrast, a cash ISA is far less appealing from a tax perspective now that the first £1,000 of savings interest income is tax-free. It means that an individual will need to have around £67,000 in savings before a cash ISA offers a higher post-tax return than a bog-standard savings account. As a result, the attraction of a cash ISA is falling, while a Lifetime ISA or a SIPP could become increasingly profitable for investors over the long run.
