The Bank of England raised interest rates to 4% last month, their highest level for 15 years. And even with these higher returns, Cash ISAs still seem like a terrible deal to me. If I wanted to build passive income from my savings, I’d invest in a Stocks and Shares ISA instead. Here’s why.
42p interest a month
Several years ago, I opened a Cash ISA after saving a few pennies from my first real job. I wanted to be smart about my money, invest for the future, and maybe start building up enough cash for a deposit to buy my first home.
I got a shock when I opened my online banking account after the first month. My Cash ISA, which had maybe £3,000 deposited, gave me back only 42p in interest for the month. I felt so disappointed. Not even a tenner a year. How would that help me save for a house deposit?
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The poor returns were partly due to the low interest rates back then. Fast forward to 2023, and we have a 4% interest rate. So are Cash ISAs a good deal now?
Cash vs stocks
An article published in The Guardian last year showed that only two out of 233 savings accounts passed on the full interest rates rise to customers. Even now, the highest rate I can find on a Cash ISA is 3.1%.
When I purchase shares in a Stocks and Shares ISA on the other hand, it’s a much more even playing field. I get the full returns minus a one-off trading fee. And with historical returns in British large-caps on the London Stock Exchange being around 8%-10%, I feel the gains are much more lucrative too.
Let’s compare the returns of a Cash ISA and a Stocks and Shares ISA with an initial £20,000 stake.
| Cash ISA | Stocks and Shares ISA | |
| Percentage Return | 3.10% | 9% |
| Starting Amount | £20,000 | £20,000 |
| 10 years | £27,140 | £47,347 |
| 20 years | £36,830 | £112,088 |
| 30 years | £49,979 | £265,354 |
The stark difference between how much 9% and 3.1% earns – over £200,000 in interest – shows clearly why I think owning stocks is a better way to build long-term wealth.
There are more risks involved with investing in stocks. Historical returns may not be the same as future performance. And an advantage of Cash ISA is that returns are guaranteed, which makes them much more suitable for short-term saving.
A passive income source
At some point, I will want to withdraw funds to create a passive income. A useful phrase here is ‘safe withdrawal rate’. This is basically how much I could take out while keeping my original sum more-or-less intact. Studies have shown 4% to be safe over multiple-decade timeframes.
The 4% safe withdrawal rate of that 30-year figure of £265,354 offers a £10,614 income per year. That’s nearly £900 a month from investing in stocks, an amount higher than the state pension. I’d like that as an extra income source over the long term.
I’ve been working towards a future income like this for a few years now and the reality is not as cut and dry as the example above. But by ‘drip-feeding’ spare cash into stocks and investing in quality companies? I’m seeing real progress towards what I hope will be a lifelong passive income.
