An ISA is a boon to any investor. For the current year we can stash away cash or shares up to £15,240, and not pay a penny in tax on any share price appreciation or interest, and pay no further tax on dividends.
This year’s allowance runs out on 5 April, and anything you don’t use will be lost — you can’t carry anything unused over from one year to the next.
But the very next day you’ll have a whole new allowance to use, I hear you say. Most people don’t have a spare £15,240 to invest every year anyway — and if you’re young, you’ll probably be earning more money in the future and better able to use up your allowance then, won’t you?
Get in early
All that might be true, but every extra pound that you can invest in your ISA now can compound up to a very tasty sum in another few decades time. A pound invested early in your life can be worth far more than a pound invested later.
I’d recommend shares instead of cash every time, so how well are you likely to do in the stock market?
Since this time last year, the FTSE 100 has gained an impressive 19% in share price rises and has paid out around 3% in dividends. That’s a total return of 22%, and a full ISA allowance of £15,240 invested in a FTSE 100 tracker a year ago would now be worth £18,593.
You’d be sitting on a profit of £3,353 (less management charges, which are very low these days), and if you’d only invested half of your allowance you’d only have half the profit at £1,676. That much is obvious, but here’s what might surprise you… how much do you think those two sums would be worth in another 40 years?
You’re very unlikely to get 22% per year in the long term, but something like 6% per year in total returns is certainly feasible. So, if you took that £3,353 profit, invested it at an average return of 6% per year (some years will do much better, some will lose money) and reinvested your dividends, you’d end up with… £34,490.
The £1,676 first-year profit you’d given up by only using half of your allowance would have actually cost you £17,245 in lost gains in the long run. That’s quite a difference.
Make the most of time
To show how early investments are so important, let’s suppose you’re just setting out on your working career and you’re able to invest the whole £15,240 allowance in your ISA every year… but you decide to do that for only the first five years (for some reason that I can’t imagine).
On a modest total return of that 6% per year, which is probably a reasonable expectation over a long period, you’d have £88,676 at the end of five years. If you then didn’t add an extra penny to the pot until the end of a 40-year working life, it would still have compounded to nearly £682,000 over the next 35 years.
Now, imagine a different approach where you decided to postpone your investing until later in life when you’re earning more. How late could you leave it?
You’d have to start 22 years ahead of retirement day to achieve the same result. The first five years of a 40-year investing strategy are worth as much as the last 22.
So use your ISA now.