Interest rates at 5%! Can I now earn more with a Cash ISA than a Stocks and Shares ISA?

The earnings potential of Cash ISAs got bumped up by the Bank of England recently. How do they now compare to a Stocks and Shares ISA?

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Since the Bank of England nudged interest rates up to 5%, I’ve been looking at the knock-on effect for savings accounts. One question, in particular, stands out to me. Would a Cash ISA generate better earnings than a Stocks and Shares ISA?

What could I earn in savings accounts?

First, let’s look at how much I’d earn with a Cash ISA. Sadly, rates being at 5% doesn’t mean I’d earn that much. The BoE’s Base Rate sets the amount of interest paid to commercial banks, but the full amount isn’t always – or ever – passed on to the customer. 

The ‘big four’ banks are the worst for this. One of them – with which I have a current account – just sent me an email with the “good news” that the interest on its Cash ISA has increased to 1.36%. Safe to say I didn’t take it up on the offer.

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Smaller banks are better in this respect. Easy access Cash ISAs go up to around a 3.8% return. One-year fixed ISAs can reach up to around 4.9%. Some banks even offer the full 5% but with a hefty minimum deposit requirement.

So, I could earn close to 5% interest a year in interest that’s safe and guaranteed. But will I earn more than with a Stocks and Shares ISA?

Investing in UK shares

Perhaps I could. While a Cash ISA offers a fixed amount, investing in the stock market is unpredictable. There are boom years and bust years, good companies and bad companies. The amount I will earn is impossible to say.

That said, many investors in UK shares would consider a 5% return to be a substandard return.

For one, a lot of UK companies offer more than that in dividend payments. For example, BT offers an annual yield of 6% and Aviva offers 8%. Actually, by my count, 29 of the FTSE 100 firms have a 5% dividend or higher right now. 

And that’s only part of the equation. Many shares offer growth opportunities as well, which means the shares I own would be worth more. The difficulty is that stocks are volatile. It’s impossible to guarantee a yearly return. 

I think it’s best to look at total returns from UK shares over time. Looking at recent decades, the big FTSE 100 firms have offered an average of 8% per year. The smaller, more UK-focused FTSE 250 firms have offered roughly 10%. 

The long and short of it is that a Stocks and Shares ISA is the winner here – for me, at least. Over the long term, I’d expect more than 5% from investing in UK shares, although this comes with a caveat.

A caveat

One important thing to mention is the return from a Cash ISA is guaranteed. Returns from investing in UK shares aren’t a certainty. Let’s say the stock market crashes in the next year or two, then I’d expect to earn more from a Cash ISA. 

What it comes down to is both types of ISA have their uses. And actually, I did open a Cash ISA recently. The return looked decent enough for a little spare cash I had lying around. Overall though, I still think investing in UK stocks has far greater wealth-building potential.

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John Fieldsend 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.

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