With the FTSE 100 having declined by over 10% in the last five months, it is understandable that many investors are feeling nervous about their portfolios. After all, they are likely to be valued at a lower level than they were earlier this year, and there is the potential for recent declines to continue.
Increased uncertainty could mean that many investors become somewhat fearful regarding their investment portfolios. This could lead them to determine that a cash ISA may be a better place to invest. It offers stable returns which, in recent months, have outperformed the FTSE 100. In the long run, though, investing in a cash ISA rather than shares could prove to be the wrong move.
Real returns
Although cash ISAs may outperform shares over short-term periods where the latter experiences declines, the reality is that inflation remains above the return on a cash ISA. This means that over time, the real-terms value of any investment in a cash ISA is likely to fall. As a result, having too much wealth invested in one over the long term could be detrimental to an individual’s standard of living, since it will be unable to maintain its spending power.
The FTSE 100, on the other hand, has a long track record of beating inflation. It has the potential to deliver high single-digit total returns, while a dividend yield in excess of 4% suggests that its income return alone is likely to beat inflation during normal market conditions.
Bear market
Although the FTSE 100 is still some way off bear market territory, it would not be a major surprise for the index to fall by another 10%. There are significant risks facing the world economy, such as tariffs, Brexit and rising US interest rates. They could impact negatively on investor sentiment and cause share prices to decline yet further. In such a scenario, cash ISAs may outperform stocks over a period of months.
In the long run though, a bear market could be a buying opportunity for investors. High-quality companies may end up trading at lower valuations, which could provide wider margins of safety. This could lead to higher return potential, as well as lower risk, for investors who are looking five or 10 years ahead. As such, if the FTSE 100 does experience further volatility, it may be the right time to dump a cash ISA, rather than invest more capital into it.
Outlook
As mentioned, recent stock market volatility could continue. However, this is nothing new for the index. The FTSE 100 has always been relatively volatile, and it has always followed a cycle of ups and downs. Focusing on company valuations could be a sound means of judging when the rises and falls provide the greatest opportunities for investors. Although cash ISAs may offer less risk in the short run, in the long run they seem to offer little return appeal versus the FTSE 100.
