Cash ISAs will likely lose you money. It sounds counter-intuitive because tax-free cash savings accounts are supposed to be safe. However, the reality is that with annual inflation running at approximately 1.2%, most Cash ISAs aren’t worth it. They simply don’t give you enough interest to cover the annual increase in prices.
To be fair, if you’re aiming to make a passive income, putting your money into a Cash ISA is probably better than stashing your hard-earned cash under the mattress. Indeed, a small interest payment is better than none. But, even the best fixed-rate Cash ISA only pays around 1.4% in interest. Moreover, you’ll likely have to tie your money up for a few years to get this rate.
I think there are better ways of generating a passive income that give you the flexibility to make the most of your wealth, whether that’s by spending it or by compounding it.
Index tracker funds
Index funds aim to track an index, not beat it. However, because of this they’ll also likely exceed the returns from most other funds over the long run.
Moreover, index tracker funds are boring. And this is good. Index funds trade far less frequently than other types of funds, meaning lower expenses and higher returns. And, as the aim of the fund is to mimic an index, there’s no gambling on the next big thing.
All this means you can buy an index tracker fund and forget about it, all the while knowing it’s allowing you an efficient means of earning a passive income.
Income investing is one of the simplest ways to create a passive income. Currently, with bond yields so low, dividend income on many FTSE-listed stocks exceeds the return on many bonds. Moreover, the average rate of return on many short-term bonds is lower than the annual rate of inflation. This makes dividend-paying stocks all the more attractive.
In addition, unlike even the best Cash ISA, you can choose whether to reinvest the dividends or to pocket the payments. Either way, dividends from great companies with strong balance sheets and stable cash flow is a great way to build your passive income and increase your wealth.
Cheap shares provide for better returns than a Cash ISA
Lastly, buying shares in reputable companies and holding them for the long term is another great passive income opportunity.
Indeed, buying shares after a stock market crash means many firms are on sale. After every previous stock market crash, the Footsie has rebounded. Moreover, the average return for the FTSE 100 since its inception is around 5%, far higher than even the best Cash ISA. And lower share prices mean greater potential capital gains as the index recovers once again.
Don’t lose your wealth by putting all your money into a Cash ISA. I think there are better ways of making a passive income from dividends and stock market returns. Moreover, they allow you to keep access to your money. And while many shares are going cheap, the best time to start is now.
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Rachael FitzGerald-Finch 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.