I don’t think there’s a better way to grow wealth than through an ISA. The thousands of people who became millionaires in their Stocks and Shares ISA last year will agree. And a £20,000 starting stake could hand me a surprisingly large passive income – as we’re about to discover.
But a Stocks and Shares ISA doesn’t automatically churn out free money. While the stock markets boast an excellent track record when you smooth out the ups and downs, plenty of investors lose money or achieve subpar returns.
What’s the difference between losing cash and building a lifelong passive income source? It comes down to one thing. How I invest.
Parking cash
Take the FTSE 100 for instance. I could throw my entire £20k into a FTSE 100 index fund and get an average of all the stocks in the index. As the 100 largest public firms in the UK grow, make money, or pay dividends, I cash in.
The Footsie boasts a historical return of around 7%. Sounds decent enough. Time to park my £20,000 in one of these? Well, here’s how my money might grow over an investing career.
| £20,000 ISA | |
| 7% | |
| 1 year | £21,400 |
| 5 years | £28,051 |
| 10 years | £39,343 |
| 20 years | £77,394 |
| 30 years | £152,245 |
Okay, so over an investing timeline my £20k snowballs into £152k.That’s pretty good going and I’d then withdraw at 4% to net a passive income of £6,089 each year. Not bad. But what if we could go one better?
The Stocks and Shares ISA gives me lots of freedom to do so. I don’t need to limit my investment to ‘boring’ total market funds. With modern brokerage apps, in seconds I can own a share in almost any public company on the planet.
With so many firms to choose from, I might begin by browsing companies in my area of competence. By looking at companies that I know and use, I have a better understanding of the products sold and the customers’ buying motivations.
Personal experiences can help spot quality companies even more than reams of numbers on a 100-page trading update. As famous investor Peter Lynch was fond of saying, “buy what you know”.
Rewards
Of course, this style of investing poses risks. The fewer stocks I buy, the more exposed I am to downturns. A strategy like this is safest with a stake that is secondary to other sources of income like a pension.
But the rewards can be extraordinary if I succeed. With good but sensible stock choices, I might aim for an 11% return. Here’s how my £20,000 ISA would grow with this new rate of return.
| £20,000 ISA | ||
| 7% | 11% | |
| 1 year | £21,400 | £22,200 |
| 5 years | £28,051 | £33,701 |
| 10 years | £39,343 | £56,788 |
| 20 years | £77,394 | £161,246 |
| 30 years | £152,245 | £457,846 |
Now my stock picks have bumped up the cash earnings to nearly half a million. My bumper ISA looks impressive on its own, but with a 4% return I could pull out a yearly £18,314.
Such passive income is all the inspiration I need to keep searching for more quality stocks for my ISA.
