Investing in a Stocks and Shares ISA can be a great way to build up a pot of money. But while investment returns are typically higher than savings over the long term, the risk can also be greater.
Thinking carefully before making moves in the stock market is crucial. With that in mind, here are some principles I’d look to stick to when investing the yearly £20,000 ISA contribution limit.
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Invest in the best
Whether it’s for building wealth or earning passive income, I think the most important thing is to stick to buying shares in high quality companies. This menas a couple of things.
First, it means stocks where the underlying business has good profitability. This can come either from wide margins or high returns on invested capital.
FTSE 100 company Diageo is an example of both – the firm managed an operating margin of 27% and earned a 75% return on its fixed assets last year. Both of these numbrs are very good.
Second, looking for quality involves concentrating on businesses that will be able to maintain their profitability over time. This can manifest itself in a number of ways.
In the case of Diageo, the company’s brands allow it to remain profitable. With leading products in a number of categories, its customers keep coming back to things they know they like.
The importance of investing in quality businesses is something that billionaire investor Warren Buffett emphasises. And I also think it’s key when it comes to building wealth over time.
Slow and steady wins the race
The other thing I think is important for building wealth in the stock market is to have a long-term view. Thinking in terms of years and decades, rather than weeks and months, is vital.
In the short term, share prices might go anywhere. But – especially with shares in strong companies – prices tend to rise over time.
One of the best illustrations of this is AstraZeneca. The company’s stock has fallen by around 11% over the last six months, but anyone who bought shares five years ago is up 75%, plus dividends.
That’s enough to turn a £20,000 investment into something worth more than £35,000. And there’s no way I could have got a return like this from a savings account.
Astrazeneca is a bit of an extreme example, but something similar is true of stocks in general. The FTSE 100 returned around 2% in 2023, but its long-term average is much closer to 6.5% a year.
The short-term volatility of the stock market makes it unsuitable for anyone who might need their money quickly. But for long-term wealth, I think it’s far better than a savings account.
Investing £20,000
The difference between earning 6.5% a year – the average annual return of the FTSE 100 – and the 4% investors can currently get on savings might not seem like much. But it adds up over time.
So £20,000 invested at 4% for 10 years compounds to £29,604. That’s not bad, but at a 6.5% return, that same £20,000 becomes £37,542.
Investing is riskier than saving and there are no guarantees that stocks will return 6.5% in the future. However, I think they are clearly the best way of building wealth over time.
