For me, a Stocks and Shares ISA can be a useful vehicle to try and build long-term wealth. In fact, taking the long-term approach to investing as I do, I think tucking my money away in an ISA and letting it get to work is very attractive.
But with some attractive interest deals available for Cash ISAs right now, I could use one of them and avoid the capital loss risk present in a Stocks and Shares ISA.
Why am I not doing that? I think I might get a bigger return overall by putting my ISA to work in the stock market!
As an example, imagine I wanted to target a 12% return on my ISA share portfolio. Here is how I would go about it.
Choosing a timeframe
When setting my target, a small but important piece of definition will help me clarify my investment objective and strategy.
If I want an annualised return of 12%, or what might be described as my compounded annual growth rate, it means I want my average return to be 12% a year for the lifetime of my Stocks and Shares ISA. Even though some years I may do worse, in others I could do better, meaning I still hit my target.
As an example, Warren Buffett’s company Berkshire Hathaway has produced a compounded annual gain in its per-share market value of 19.8% since 1965. Last year it only managed a 4% annual gain. But the average is much higher than that, thanks to years like 2021 when the annual gain was 29.6%.
An alternative that should be easier to hit is aiming for a regular annual return of 12% — but not immediately.
Power of compounding
How might that work in practice? Imagine I invest in dividend shares that yield around 8%. I could withdraw my dividends as I receive them, meaning I would earn an 8% annual return from dividends alone.
But if I instead reinvested them (something known as compounding), after 11 years I would be earning a 12% annual return on my original investment, presuming constant share prices and dividends.
Simply by forgoing cash dividends in the first few years, I could increase my annual return down the line without needing to invest any more cash.
I would not sacrifice quality for yield when selecting shares. After all, dividends are never guaranteed. But right now, quite a few blue-chip FTSE 100 shares have dividend yields over 8%, including British American Tobacco, Legal & General and M&G.
Quality on sale
Above, I explained how I could aim for my 12% return target using dividends alone. If I choose quality companies that can grow their profits over time, buying when they are attractively valued could help me benefit from a rising share price as well as dividends.
But even if I buy great companies, if I overpay I could see my investment value shrink as the share price falls.
That is why I aim to build a Stocks and Shares ISA stuffed with a range of great businesses. But I do so patiently, waiting for share prices I think offer me good value.
