Forget a Cash ISA! I’d invest £20,000 in a Stocks and Shares ISA to earn passive income for life

The Bank of England raised interest rates to 4% last month, the highest level in 15 years. And even with this higher return, the Cash ISA still looks like a terrible deal to me. If I wanted to create passive income from my savings, I would invest in a Stocks and Shares ISA. Here is the reason.

Interest is 42p per month

A few years ago, I opened a Cash ISA after saving some money from my first real job. I wanted to be smart about money, invest for the future, and maybe start building up enough cash for a deposit to buy my first home.

I was surprised when I opened my online bank account after the first month. My Cash ISA, in which I have maybe £3,000 deposited, gives me back just 42p in interest for the month. I feel very disappointed. Not even ten years. How can it help me save my home deposit?

Poor returns are partly due to low interest rates. Fast forward to 2023, and we have an interest rate of 4%. So, are Cash ISAs any good now?

Cash vs. stock

Articles published in The Guardian last year showed that only two of the 233 savings accounts passed on the full interest rate up for customers. Even now, the highest rate I can find on a Cash ISA is 3.1%.

When I buy Shares in Stocks and ISA Shares on the other hand, it’s more of an even playing field. I got a full refund minus the one-off trading fee. And with the return of history in English large-caps London Stock Exchange around 8%-10%, I think I get more profit.

Let’s compare the returns of a Cash ISA and a Stocks and Shares ISA with an initial £20,000 of shares.

The stark difference between 9% and 3.1% earned – over £200,000 in interest – clearly shows why I think shares are a better way to build long-term wealth.

There are other risks involved in investing in stocks. Historical returns may not be the same as future performance. And the advantage of the Cash ISA is a guaranteed return, which makes many people more suitable for short-term savings.

Source of passive income

At some point, I want to withdraw funds to create passive income. A useful phrase here is ‘safe withdrawal rate’. Basically this is how much I can do while keeping my original amount more or less intact. Studies have shown 4% to be safe for decades.

A safe withdrawal rate of 4% of that 30-year figure is £265,354 offering an income of £10,614 per annum. That’s almost £900 a month from investing in shares, an amount higher than the state pension. I want it as an additional source of income for the long term.

I’ve been working on future earnings like this for a few years now and the truth is it’s not as cut and dry as the example above. But by ‘drip-feeding’ spare cash into stocks and invest in quality companies? I’m seeing real progress towards what I hope will be a lifetime of passive income.