A cash ISA could damage your retirement savings. Here’s why I’d buy FTSE 100 shares instead

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After over a decade of rock-bottom interest rates, the UK’s monetary policy is expected to tighten over the next few years. This could mean that the interest paid on cash ISA balances increases, which may increase the product’s appeal at a time when the FTSE 100 is facing an uncertain future.

The reality, though, is that it’ll take multiple interest rate rises before cash ISAs are able to offer an inflation-beating return. And while the FTSE 100 may experience further volatility, its track record suggests it may be a far superior means of generating growing retirement savings in the long run.

Low returns

With it being difficult to generate more than 1.5% in interest from a cash ISA at the present time, investors are recording negative returns once inflation is factored in. In other words, any amount invested in a cash ISA will have less spending power in a year’s time than it does today. For investors who are using a cash ISA to plan for retirement, the results could be hugely disappointing. What had seemed to be a sizeable nest egg today could become increasingly inadequate due to its reduced spending power.

Volatility

Of course, cash ISAs have historically held appeal for individuals who are concerned about the risk of loss with other assets, such as shares. The reality, though, is that the vast majority of people have a long-term time horizon when it comes to retiring. They’re usually over 10 years away from finishing their working lives, and so it could be argued that there’s time for declining asset prices to recover prior to their retirement date. As such, the risks inherent in buying shares may be real, but could ultimately not pose the challenge which some investors expect.

High returns

While cash ISAs may fail to keep up with inflation over the long run, the FTSE 100’s dividend yield of 4.7% is more than double the rate of inflation. This suggests it could offer superior retirement savings prospects than a cash ISA, while the index’s track record of growth indicates that investors may expect high single-digit total returns per annum over the long run.

Of course, there are risks facing the world economy which could weigh on the FTSE 100’s performance in the near term. For example, there’s a risk of a trade war between the US and China, while Brexit uncertainty could cause investor sentiment to weaken further over the coming weeks. And with China’s economy showing signs of slowing, it could prove to be a volatile 2019.

The key takeaway for investors, though, is that share prices experience periods of high volatility where their valuations can come under pressure. In the long run, though, they have historically outperformed cash savings, which may make them a better place to invest in order to build a retirement savings fund.

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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.

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