Have you heard about all the ISA millionaires in the UK? Do you want to be one? Here’s how I think you can do it.
Stocks and Shares Individual Savings Accounts (ISAs) are a decent tool to help you build up your wealth towards the goal of achieving savings and investments worth £1 million.
One great thing about them is that although you receive no income tax relief on the money you pay in, all your investment gains and income are tax-free, and there’s no income tax to pay when you take your money out.
Another benefit is that you can put up to £20,000 per year into an ISA, which strikes me as a generous tax-sheltered allowance for most people on an average wage.
A third awesome perk is that Stocks and Shares ISA allows you to invest in shares and share-backed funds, which means you’ll get exposure to an asset class that has a long history of outperforming cash savings, and every other major class of asset too.
The exponential process of compounding
My Foolish colleague Rupert Hargreaves explained in an article recently how he’s aiming to become an ISA millionaire over a period of 21 years. This involves putting the maximum £20,000 in his ISA account each year in equal monthly payments of £1,666, and earning a return of 7% each year.
However, I think saving that much every month could be a stretch too far for many. If you save less per month, the process will take longer, but you can still do it. It’s important to save as much as possible and to start as soon as possible.
The process of compounding works exponentially, meaning the growth in the size of your investment pot accelerates over time. The sooner you get started, the sooner you’ll start seeing those big absolute annual returns that will arrive towards the end of your saving and investing journey.
But where can you get an annualised return of 7% like the one Rupert used in his example? He worked out that by investing 50% in an FTSE 100 accumulation tracker fund and 50% in an FTSE 250 accumulation tracker fund he could get a return like that, based on what those indices have produced historically. The ‘accumulation’ part of the description means that dividend income is automatically reinvested back into the fund, which helps with the process of compounding your money.
Some things are worth the effort
I’m a big fan of tracker funds that follow market indices. If you want a file-and-forget investment, I don’t think you can go wrong with a tracker. Indeed, you’ll get instant diversification across the many firms making up the index, which means you’ll reduce the risk to your capital from any one badly performing company. You’ll also remove the need to manage the shares in your portfolio. Instead, you’ll be investing in the index whatever it does.
But if you like the idea of putting research and management time into investing, it’s possible to invest your way to a million faster. Popular strategies include harvesting dividends from firms with stable businesses, hunting down growth shares, and investing in fast-moving small-caps.
Many investors start with index investing and move onto investing in individual shares as they gain experience. With the goal of accumulating £1 million, I think it’s worth putting time into investing your money.
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Kevin Godbold has no position in any 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.