The new tax year begins on April 6, which means that from today, you have less than two weeks to make the most of your £20,000 tax-free savings allowance for the year.
Maxing out your annual ISA allowance is a good idea if you can afford to do it. Indeed, if you can put away £20,000 for 25 years, assuming a conservative rate of return of 5% per annum, you could become an ISA millionaire.
And even if you can’t afford to use all of your ISA limit, you could still reach the landmark £1m figure by following three simple steps.
Three steps to a million
The first step on the road to a million is to start saving as soon as possible on a regular basis.
The sooner you start saving, the better. For example, if you start at age 40 putting away £100 a month and earning 2% per year, with the goal of retiring at 65, you will have £38,946 at retirement. However, if you start saving £100 per month at 20 years of age, at a rate of 2%, you will have built a pot of £87,611 by the time of retirement with no extra effort on your part. This is why it’s essential to make as much use of your ISA as possible every year.
The power of time is just one tool you have available to you to improve your long term returns.
If you want to make your money work as hard as possible for you, it’s vital that you invest. The great thing is that today, you don’t have to put any effort at all into investing your money. The FTSE 250 has produced a total return of around 9% per annum for the past decade, extrapolated over 45 years, as in the example above, this rate of return is enough to turn just £100 a month into £729,120. Or, if you save for only 25 years, £111,700.
A basket of high-quality stocks, such as Unilever, Diageo and AstraZeneca could help you achieve similar returns.
If you’re saving regularly and investing, the final step you need to take is to minimise costs. Many investors don’t realise high costs are one of the most common reasons why they struggle even to match market returns. With this being the case, it’s essential you keep an eye on what you’re paying out in fees.
Currently, the lowest cost FTSE 250 tracker fund charges investors only 0.09% per annum in fees. Meanwhile, the average change for an actively managed fund today is 0.9%. That’s 10 times higher. If I plug this into the above example: £100 a month, invested at a rate of 9% per annum, with a cost of 0.09%, will be worth £679,930 at age 65. On the other hand, if you pay out 0.9% per annum in fees, the pot will only be worth £525,055 at age 65, that’s a difference of £154,875!
These examples illustrate how easy it is to build a fortune if you follow just a few critical steps. You don’t need to spend thousands on advisors or start off with an extensive portfolio, as long as you save regularly, invest sensibly and keep costs low, over time, your pot will grow.
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Rupert Hargreaves owns shares in Unilever. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended AstraZeneca and Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.