Forget a cash ISA if you want to make a million. Here’s what I’d do instead

Stack of new bank notes

I reckon the cash ISA is one of the deadest ducks that’s currently being offered to the investing public.

Wanting to save some money and not pay any tax on the interest sounds like a great idea, until you realise what pathetic rates of interest they’re offering these days.

I’ve just looked, and the best no-strings-attached rates I can find top out at around 1.5%. You can get a bit more for fixed-rate, fixed-term accounts — but if you don’t need short-term flexible access, that’s one more reason not to go for a cash ISA anyway.

Inflation

The UK Consumer Prices Index rate of inflation dropped to 2.1% per year in December, down from 2.3% in November. Even though that’s the lowest it’s been for two years, it’s still higher than those 1.5% top cash ISA rates — and that means investing in a cash ISA will actually lose you money in real terms.

Sorry, did I say “investing”? Obviously that’s not what it is, it’s throwing money away. But you don’t have to pay any tax on the interest and so you can avoid losing even more? Big deal.

Your chances of achieving millionaire status using a cash ISA? Well, if you save £100 in a cash ISA at these rates, you won’t even be a hundredaire after inflation when you take it out.

Putting inflation to one side for a moment, how long might it take to accumulate a million in a cash ISA?

How long?

If you can afford to stash away the full £20,000 ISA allowance per year, at today’s 1.5% interest rates you could actually do it in 38 years. But, if inflation remains at the current 2.1% for the entire period, you’d lose a big chunk of cash in real terms.

In fact, you’d have saved (I just can’t say “invested”) a total of £760,000 over those 38 years and ended up with £1.02m — but inflation would have eroded its worth to just £679,000 in today’s money.

Of course, only those with a very good income could spare £20,000 per year anyway, and they’re far more likely to be kinds of people who would go for a Stocks & Shares ISA every single time.

In fact, if you invested the same sum in a Stocks & Shares ISA and you achieved a total annual return of 6% (which I think is certainly achievable, especially now with the FTSE 100 forecast to provide 4.9% in 2019 from dividends alone), the same 38 years would result in a pot of £2.8m.

Nice result

And adjusting for the current rate of inflation at 2.1%, you have the equivalent of £1.7m in today’s money — a pretty good return on the £760,000 you’d have invested overall.

But the real test is — do investors really achieve millionaire status by investing in Stocks & Shares ISAs? And the answer is a big YES. 

At the time last year’s ISA deadline was approaching, there were estimates of around 1,000 ISA millionaires in the UK — and they did it by investing in stocks, not by watching their money dwindle away in a cash ISA. And interestingly, the best performances appear to be from investing in a relatively small number of high-quality companies. 

When should you start? How about right now?

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Alan Oscroft 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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