Investing for the long term in a Stocks and Shares ISA is one of the best ways to build wealth in the UK.
Most ISAs offer a choice of thousands of different stocks, investment trusts and exchange-traded funds (ETFs). The real wealth-building benefit, though, is that all gains I make are totally tax-free within the annual £20k allowance.
Here, I’ll consider how much money I could make after five years if I invest £20k in one of these accounts.
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Going on averages
Now, the first thing to point out is that precise stock market returns are ultimately unknowable. But what we do know is that markets have trended upwards over time.
In fact, a century of stock market data from the US and UK tells us that the annualised total return (both share price gains and dividends) is between 7% and 10%.
That said, the iShares world index fund below shows us that global stocks have returned about 74.5% over the past five years.
If they did so again, which is far from guaranteed, I’d have £34,900.
This assumes I don’t take out my dividends and spend them. Ideally, I’d want to reinvest them back into buying more shares. This way, I’d really start to harness the incredible power of compounding.
Active investing
As mentioned, the above figures are averages. It’s what I might hope to achieve investing passively.
But could I beat the market average by actively investing in individual stocks and funds? Well, this is harder to do and would obviously depend on what I buy.
In the UK, two perennially popular investments are Fundsmith Equity (managed by Terry Smith) and Warren Buffett’s Berkshire Hathaway.
According to my calculations, a £20k investment split evenly between these five years ago would now be worth around £38,700. So, a handy bit of outperformance relative to the global index.
Of course, I could be accused of cherry-picking here. But they’re hardly obscure picks. They’ve both been fantastic long-term compounders, beloved by many.
Investing in excellence
I try to find excellence, buy excellence, and add to excellence over time. I sell mediocrity. That’s how I invest.
David Gardner, co-founder of The Motley Fool
Finally, we should remember that an individual five-year period can be very different from another.
Take the last five years, for example. We had the first global pandemic in a century, followed by the largest military attack on a European country (Russia on Ukraine) since World War II. Then surging inflation was met with the fastest interest rate hikes in modern history.
Stock markets don’t like uncertainty, as the saying goes. And the last five years have contained enough unpredictability and tragedy to fill a few decades.
But the crucial point is that great companies survive periods of turbulence. Not only that, they often get stronger as weaker competition falls by the wayside and investors rush to put their money behind them.
Wrapping up
So how much could I make in five years? Well, the average suggests 7%-10% per year. But nothing is certain and it may be less (or more).
But if I were to find individual stocks that massively outperform — similar to Frasers Group (up 291% in five years) or Ferrari (up 276%) — then it would be significantly more.
The Foolish takeaway is that picking stocks in an ISA can potentially deliver huge returns for everyday investors like myself.
