A Stocks and Shares ISA can be a good vehicle to try and build wealth over the long term.
If I had a spare £20,000 in an ISA and wanted to try and increase it to £50,000 over coming years, here is how I would go about it.
Growth and income
As an investor in the stock market, there is a choice of growth and income shares. The description is only a rough one. Some shares offer the prospects of business growth and dividend income, while others offer weak growth prospects and no likelihood of a dividend.
Roughly speaking though, it can be a useful way to categorise shares.
To grow the value of my Stocks and Shares ISA, I need either an increase in the price of my shares or dividend income from them.
If I am fortunate, I may get both! When selecting a share to buy though, I ask myself what I hope will be its primary source of wealth-building for me over the years to come. Price growth or dividend income.
If I had a spare £20,000 in an ISA right now, I would put 60% into dividend shares and the remainder into growth shares.
Long-term dividend potential
The sorts of dividend shares I would buy for my ISA would be similar to (and in some cases the same as) ones I already own, like Legal & General and Vodafone.
I would be looking for blue-chip companies with a long-term competitive advantage I think could generate chunky free cash flows to fund dividends.
Some businesses may end up disappointing me. So I would split the £12,000 across a handful of different income shares.
In the current market, I think an average dividend yield of 8% is attainable even while only investing in FTSE 100 companies with proven businesses.
Going for growth
Turning £20,000 into £50,000 is equivalent to growth of 150%. If I could compound my dividends at an annual rate of 8%, the value of my income shares should increase 150% in 12 years.
That example presumes a flat share price and dividend in each case. In practice that is unlikely – both things could move up or down. But it shows how compounding dividends can help to build wealth.
With the remaining £8,000 of my Stocks and Shares ISA going on growth shares, I have to accept that finding attractively priced growth shares can be difficult.
To hit my target, I would be looking for shares in dynamic businesses with strong growth prospects. I would want to buy at a valuation I think could allow for an increase in value 150% over the coming decade or so.
In the past decade such a return was achieved by growth shares like JD Sports and Ashtead.
Past performance is not a guide to what will happen in future. But I would look now for similar characteristics to those such companies had a decade ago, namely a large target market, strong competitive advantage and proven business model.
As well as that, valuation is critical. I do not just want to find business I think have strong growth prospects. I also want their shares to be attractively priced.