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A cash ISA has looked like an attractive option in recent years, with the best ones offering tax-free passive income of around 5% a year.
They've taken investors' cash out of the stock market, and that's no surprise. After all, Cash ISA interest is guaranteed… at least for the duration of the agreement.
Why risk losing money just to get a percentage more in stocks and shares? In the short term, why? But I think there are good reasons for long-term investments.
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Risk versus reward
ISA cash returns look good now, but when interest rates return to their long-term trend, that will surely change.
Meanwhile, the FTSE 100 has achieved a long-term average annual return of around 7.5%, with the FTSE 250 reaching 11%. And they will surely look even better when cash ISAs return to a measly percentage.
Now, both stock indices carry risks. And we normally consider the smaller shares in the FTSE 250 to carry greater risk than the larger ones in the FTSE 100. So I'm not going to invest every penny I have in them. But I'm happy to buy and hold some as part of a diversified stocks and Shares ISA.
And even if I don't have the cash to use my full ISA allowance, I can dream of investing that amount in FTSE 250 shares, right?
Long-term returns
Are there any you can use as an example of how dividends and price gains can add up to a lot of cash?
I see open (LSE:ABDN) has an expected dividend yield of 9.6%, so it wouldn't take a big price gain to hit that long-term average ratio of 11%. And the share price is down in five years, so is this an opportunity to make cheap profits?
It is an investment company and you would expect its earnings and share price to be more volatile than the market itself. When stocks rise, more people pour money into companies like abrdn and can beat the market.
But then, in periods of crisis, shareholders can sell and drive investment management stocks down. It's really not nice to see similar stock prices fall while inflation and interest rates rise.
Passive income
Anyway, what could you gain by investing £20,000 in abrdn shares, just from the dividends? Assuming the yield remained at 9.6%, such a lump sum could grow to £125,000 over 20 years. And that could allow me to pay my £1,000 a month in passive income.
If you could hit the 11% average of the FTSE 250, you could increase it to £1,400. And even 7.5% of the FTSE 100 could add £530 to my income each month.
I would never put all my eggs in one basket. And I would only buy shares like abrdn as part of a diversified ISA. But doing sums like this convinces me that shares are a much better option for long-term returns than a cash ISA.
