Being able to make a million pounds in the stock market and retire comfortably, is a dream for many investors.
However, most investors give up before they even start, because they think they face an uphill struggle to reach this life-changing amount of money.
But in reality, it is not impossible to make a million if you follow a strict savings plan and invest your money sensibly.
A stocks and shares ISA is a great tool to help you achieve this goal. Capital gains and income on investments in an ISA are tax-free, and you don’t even need to declare the gains or dividend income on your tax return. The benefit of this is that you can keep more of the money you earn, and over time, the extra benefits of not having to pay tax really add up.
The power of compounding
The best tool investors have to help them make money in the stock market is compound interest. Albert Einstein once called compound interest the eighth wonder of the world, and it is easy to see why.
Compound interest is effectively the process of your money earning money. For example, if you save £100 and put it in a high-interest savings account paying 5% per annum every month, with no further contributions, the value of your funds will grow into £105.12 over the space of 12 months. That’s £5 interest on your initial investment and an extra 12p interest on the interest you earned throughout the year.
Over the long term, compound interest becomes exceptionally powerful. Over the past 10 years, the FTSE 250 has produced an average annualised return for investors of 9%. According to my calculations, if you took the same £100 from the example above, and invested it in the FTSE 250 at an average annual rate of return of 9%, after one decade it would be worth £241.20 — that’s an increase of 141.2% with absolutely no effort on your part whatsoever.
The road to a million
Compound interest is the primary tool I plan to use to build a £1m ISA account. I am planning on using a combination of the FTSE 250 and FTSE 100 in my ISA because they offer the best of both worlds. The Footsie 250 is mainly comprised of fast-growing mid-caps, while the FTSE 100 is full of blue-chip income stocks.
According to my calculations, a portfolio comprised 50/50 of these two leading indexes would have produced an average annual total return of around 7% over the past decade.
So, how long will it take me to make a million pounds at this rate of return?
As I have already filled up my stocks and shares ISA for this year, I am going to use this balance as a starting point for my calculations. Assuming I make the most of my allowance every year going forward, I will be contributing £1,666 a month to my savings pot. My number crunching shows that if I can maintain this rate of saving every year, assuming an average annual rate of return of 7% and no taxes on my money, I reckon I will have a £1m ISA account with 21 years.
It might not be the most exciting investment strategy around, but who needs excitement when you can build a £1m ISA account?
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.