The stock market is a tried-and-tested method to build wealth. Indeed, a few thousand UK investors have managed to build seven-figure Stocks and Shares ISAs by investing £20,000 a year.
Here are three approaches that have the potential to generate tax-free ISA wealth.
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.
Growth
Let’s start with the most intuitive, which is growth investing. Now, at some level, all investing is growth investing. After all, one has to grow a portfolio to build wealth!
However, I’m talking about the investing approach that focuses solely on growth stocks. These are companies that are increasing their revenue and earnings at double-digit or even triple-digit rates.
One of the most explosive growth stocks in recent times has been Nvidia (NASDAQ: NVDA). It’s up a mind-boggling 59,000% in 20 years.
In other words, every $1,000 invested back then has become $590,000!
Nvidia’s graphics processing units (GPUs), which were originally used to improve 3-D graphics, became more flexible and programmable. This saw them find wild success in artificial intelligence (AI) applications in recent years, placing Nvidia are at the heart of the AI boom.
This has sent its sales — and share price — into the stratosphere. Today, Nvidia is a $3.4trn colossus, making it the world’s second-largest company.
Naturally, it’s too large to produce similar results over the next two decades. It could even face rising competition from Chinse rivals, while the stock is trading expensively at 45 times earnings.
The risk with this investing approach is that these exciting stocks often trade at high valuations due to their higher rates of growth. This is all well and good when they’re still growing strongly. However, their share prices can collapse if growth evaporates.
Nevertheless, Nvidia stands as a shining example of what’s possible when growth investing goes spectacularly right.
Dividends
The second wealth-building approach to consider is income investing. This focuses on firms that are profitable and regularly paying out a portion of their earnings to shareholders in the form of dividends.
The UK stock market is brimming with quality income shares. Let’s assume an investor puts £20,000 per year in dividend stocks yielding an average of 5%. If those also grow in value by 5% annually, giving a total return of 10% per year, the return after 20 years would be over £1.1m!
This assumes all dividends are reinvested, and all returns compound annually at 10%. Again though, there’s no such thing as a free lunch in the stock market. Dividends are not guaranteed, and individual share prices can even fall in value over time.
Popular high-yield dividend stocks from the FTSE 100 include Lloyds, HSBC, Legal & General, Taylor Wimpey, Rio Tinto, and British American Tobacco. I received passive income from Legal & General in my ISA just last week.
Index investing
Finally, investors could consider a passive investing strategy. This involves buying low-cost index trackers.
For example, someone could split £20,000 a year between the S&P 500, FTSE 100, and STOXX Europe 600. Doing so would give exposure to over 1,000 global companies. This could also be extended to emerging markets in Asia and Latin America.
Not all geographies will produce great results (China and Asia have struggled in recent years). But this ‘owning-the-world’ strategy should produce solid long-term results, while eliminating the hassle of picking individual stocks.
