With the new tax year now under way, I am already looking at how best to use my £20,000 ISA allowance.
Given the rising cost of living, I like the fact that ISAs are exempt from income and capital gains tax. Another major positive for me is that, unlike pensions, ISAs have no age-related restrictions on withdrawals. So money invested (up to the maximum yearly allowance) can be withdrawn anytime in any amount with no tax penalties.
But how much am I targeting from it over the long run?
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.
Strong dividend returns?
My focus for ISAs has always been on high-dividend-yielding shares, as they can provide significant returns over and above any share price gains. And these can then be further supercharged through the extraordinary power of dividend compounding.
The longer the investments are held, the greater the compounding effect. This is one reason why long‑term investment horizons are often framed around a 30‑year cycle. It starts with first investments at around the age of 20 and ends in early retirement options at about 50.
The FTSE 100’s current average dividend yield is 3.1%, although these returns can go down or up over time. So, £20,000 invested at this average rate would make £7,258 in dividends over 10 years and £30,629 after 30 years.
The UK 10-year gilt (often used as the ‘risk-free rate’) has better returns, currently offering 4.8%. So, £20,000 invested here and compounded would make £12,291 in interest after 10 years and £64,172 after 30 years.
Seeking 7%+ a year minimum
I want compensation over the ‘risk-free rate’ for taking the risk of investing in shares, with 7% being my minimum. Right now, M&G (LSE: MNG) is in the select group of FTSE 100 stocks that offer around this return.
However, analysts forecast that its dividend yield will increase to 7.2% this year, 7.4% next year, and a whopping 7.7% by 2028. A risk to these rises is the high degree of competition in the financial sector, which could squeeze its margins. Another is a further rise in the cost of living that may prompt customers to close accounts.
Nonetheless, on the forecast 7.7% yield, a £20,000 investment in M&G would generate £23,089 in dividends after 10 years and £180,007 after 30 years. By then, the total value of the holding (including the initial £20,000) would be £200,007.
And this could be paying a yearly income (from dividends) of £15,401!
My investment view
I always have several high‑yielding shares in my portfolio of ISAs, not just M&G. This is because diversification of holdings in investors’ portfolios is crucial to minimising risks while maximising returns over the long-term.
As it stands, I may well include M&G in my ISA again this year. But I also have my eye on other high-yielding shares.
