Putting money into a Stocks and Shares ISA today could help me generate passive income in years to come, if I earn dividends from it.
But an alternative goal could be for me to take a 30-year view and aim to tuck the money away now and let it help me build serious wealth. Here is how.
The power of compounding
Taking dividends out of my ISA as they are paid could help me earn passive income. But I am unlikely to build serious wealth from my ISA by doing so.
Rather, I would choose to compound the dividends. That means using them to buy more shares so that, over time, the dividends would start earning dividends.
Compounding can work well to build wealth, especially for a long-term investor with a time frame in decades, not years.
For example, if I compound my £20,000 for 30 years at an average annual rate of 5%, after three decades, my Stocks and Shares ISA would be worth £86,000.
If I can achieve a compound annual growth rate of 10%, I would end up with £349,000. At a 15% compound annual growth rate, over three decades my ISA would grow to over £1.3m in value. For £20,000 invested today, I would say that counts as serious wealth!
Targeting a return
But how realistic is it to achieve such a return? It is certainly possible. Billionaire investor Warren Buffett has managed a compounded annual gain of 19.8% over the past 57 years. The S&P500 index managed 9.9% over the same period.
I am not an experienced professional investor like Buffett. But, in the long run, quality tends to show itself. If I buy the best companies and hold onto them for the long term hopefully, like Buffett, I can reap the rewards of careful business selection for my Stocks and Shares ISA.
But could that add up to a compounded annual gain of 15%? After all, M&G is one of the highest yielders in my portfolio, but it has an annual yield of 9.8%. That is high, but it is not 15%.
Growth and dividends
Over time though, compounding that yield would mean my annual return ought to grow, even if the dividend stayed flat (M&G raised its annual dividend by 7% last month).
Dividends are only one part of total return though, as Buffett’s portfolio shows. If I stuffed my Stocks and Shares ISA with companies that had great prospects, hopefully over the decades, that could lead to their share prices rising as well as dividends.
Some may disappoint me, but by spreading my £20,000 evenly over five to 10 shares, I would aim to reduce the overall impact on my ISA of any particular share doing badly.
By choosing to invest in outstanding businesses, compounding the dividends and taking a long-term view, hopefully I could become a Stocks and Shares ISA millionaire!
