Today’s tax-free ISA allowance is a massively generous £20,000. Personally, I think that’s too much. That may sound a weird thing for me to say, because who doesn’t like tax-free investing? The thing is, I believe it puts ordinary people off.
That huge allowance gives smaller investors the idea that the ISA is only for the super wealthy, rather than ordinary people too. If you invest, say, £100 a month, or £1,200 a year, you’re only using 6% of your total possible allowance. Yet £100 is a respectable starter sum, one that people can increase later when they have more money to spare.
It can go a long way, given time. Time being the operative word here, as you will see.
Say you’re 25 years old and planning to open an ISA for the first time. Once you’ve built some short-term emergency savings, to cover three to six months of salary in case of illness or redundancy, you need to look beyond the dismal returns on cash.
Say you take out a Cash ISA paying 1.5% a year, and continue to contribute a flat £100 a month. After 40 years, you will have around over £66,000. You won’t get much of a retirement for that, especially since inflation will have eroded its value in real terms.
Go for growth
With a Stocks and Shares ISA you might generate an annual return of 6% a year over the long term, after charges. And that’s being cautious because the FTSE 100 has generated an average total return of 8% a year.
After 40 years at 6% growth, your £100 a month will be worth £196,857 at age 65. If your money grows by 8% a year, you will have £335,737. That’s almost exactly five times the return from a Cash ISA. Turning £100 a month into £335,737? That’s quite impressive.
Ramp it up
The results will be more impressive if you steadily increase your contribution every year. If you hiked your original £100 by 5% every year then you should have £412,857 after 40 years, assuming an average total return of 6% a year.
If you achieve 8%, you will have £634,372 in your retirement pot. Of course, 40 years of inflation will have reduced the real value of that money, so try to invest a lot more if you can afford it.
Let’s say you invest £250 a month instead, and lift that by 5% each year. After 40 years, you should have a cool million in your ISA, or £1,032,142 to be exact, assuming 6% growth. With growth of 8% that rises to £1,585,930. At last, serious money!
Young and Foolish
Let’s say that instead of starting today you dither about and suddenly find you only have 15 years until retirement. It happens all the time. If you invested £250 a month and uprated that by 5% a year, you would still only have £101,006 at age 65, assuming growth of 6% a year, or £118,070 with 8% growth.
As you can see, your biggest friend is time. The earlier you start, the better. So 25 is not too young. In fact, it’s almost the perfect age. Although 21 is even better. Or 18. Here’s how to pick some stocks for a starter portfolio.
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Harvey Jones has no position in any of the shares 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.