Hands up if you think a Stocks and Shares ISA is brilliant for building up a tax-free passive income… is that everyone? What about those who make the most they can of each year’s limit? And never leave things until the last minute?
My hand stayed down for those two. Even if we don’t do the best we can this year, there’s another £20,000 allowance coming soon, right?
But if we don’t make the most of our opportunities today, we could forfeit some serious gains down the line. Let’s look at the difference it might make.
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.
ISA shortfall
Suppose we can invest the full £20,000 ISA amount every year. And then achieve an average return of 6.9% a year. That’s the average annual return from the FTSE 100 over 20 years, so it seems reasonable.
Do that every year, and it could grow to as much as £841,000 in 20 years. That’s £400,000 in, and £841,000 out at the end — and no tax to pay.
What if we could do that, but don’t get round to it? Maybe £5,000 below the maximum? We could end with a bit less than £631,000. That’s a whopping £210,000 short, through investing a total of £100,000 less.
Life has to be a balance. And I don’t want to live like a pauper to squirrel away every last penny I can. But money not invested in an ISA today could mean more than twice the amount lost from our 20-year gains. Do I want to buy a £10,000 car (or whatever) today and sacrifice £21,000 off my pension fund later? That would make me think differently.
We all have to tailor our investments to our financial means — I don’t have £20,000 each year to invest, for example. But seeing the difference a bit extra can make can inspire us to better results.
A starter stock?
I always think an ISA investor just starting out should consider an investment trust first. City of London Investment Trust (LSE: CTY), for example, has performed quite nicely over the past five years.
But there are two bigger attractions for me. The rise means the dividend yield has fallen a bit, though we’re still looking at an attractive 3.7% forecast. In the recent past it’s been up around 5%, or so. But more importantly, the dividend’s grown for 59 years in a row. A progressive dividend can be more valuable than a less-dependable high yield.
City of London also offers diversification, as shareholders’ money is spread across a wide range of stocks — with the top 10 all big FTSE 100 companies. I rate diversification as the number-one investing priority, especially for those starting out. Being burned at the outset could put us off for life.
Eyes on the future
There are no guarantees. And this trust could take a tumble if that run of dividend rises falters. But a diversified investment of this kind has to improve our long-term passive income odds.
So make the most of our ISA opportunities, diversify, and go for the long term. That’s my strategy.
