For most Britons, securing a dependable cash flow that allows them to stop worrying about money is the ultimate dream. But how to achieve it in reality? Well, barring an unlikely lottery win, I think the most realistic option is by investing in a Stocks and Shares ISA.
Here’s how that might look.
What is financial freedom?
In 2021, Barclays carried out research into the concept of financial freedom in the UK. The study noted the 10 most common ways that Britons defined financial freedom:
1. Having no debt
2. Mortgage paid off
3. Being confident of covering any unexpected costs
4. Feeling in control of finances
5. Saving money each month
6. Having disposable income available at the end of the month
7. Paying off all bills in full each month
8. Having a rainy-day fund set aside
9. Not worrying about when payday is
10. Paying for things without needing to check one’s bank balance first
The overwhelming theme here is about feeling in control of one’s day-to-day finances. It’s certainly not about owning fancy cars and spending every winter on tropical islands. These reported aspirations are actually quite humble and modest.
Somewhat surprisingly, the survey found that 39% of people already described themselves as being financially free. However, more than half of adults (53%) don’t think they will ever reach the point of not worrying about money.
How much is enough?
On average, the study found, people reckoned they’d need just under £60,000 a year to avoid worrying about money.
So, how many years would it take to reach that amount in passive income if I maxed out the tax-free ISA contribution limit every year?
Well, that would obviously depend on a couple of factors. The main one would be the returns I’m able to generate.
Some investors manage to regularly outperform average stock market returns each year. One is Warren Buffett, who over decades has doubled the S&P 500 index’s long-term average of 9.9%.
However, Buffett is one of the greatest living stock-pickers, so he’s clearly an exception. And research has shown that most individual investors fail to regularly beat the market.
Maxing out my ISA limit
So, let’s assume I invest £20,000 in my ISA each year and generate the average 9.9% annual return of the S&P 500 (which includes reinvesting dividends).
After 20 years of such returns, my portfolio would be worth £1,132,575.
Now, I should point out that there’s no guarantee I’ll achieve this average. I could lose money on my investments or make less than that 9.9% figure even if my portfolio values rises.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Passive income from my ISA
Let’s now assume that after 20 years I switch from reinvesting my dividends to spending the cash.
If I invest in dividend stocks yielding 6%, my £1.1m portfolio would be paying me around £66,000 a year in tax-free passive income.
Therefore, it would take me slightly less than two decades of annual £20k contributions to reach the amount needed to declare myself financially free (as defined by most Brits today).
Of course, this doesn’t factor in future inflation, which is worth bearing in mind. And individual dividends aren’t guaranteed, so diversification would be a must.
It’s also worth pointing out that I could reach my goal sooner by investing in outperforming growth stocks. I’m talking about the next Nvidia or Tesla, though this is riskier and identifying them is easier said than done.
Finally, like many things in life, the ingredients for success here are persistency and patience. Reminding myself of this would keep my eyes on the prize when markets hit rocky patches.
