I reckon a Stocks and Shares ISA is a smart way for most investors to own shares listed on the stock market. You can put up to £20,000 per year into your ISA, and your gains from investing in shares within the account will be free from tax.
That means no capital gains tax if your shares go up, no tax on dividends you receive, and no income tax when you finally withdraw money from your ISA, perhaps in retirement. However, the money you pay into your ISA will be net of any liability you have for income tax, so there’s no tax relief for money on the way into the ISA.
You could aim to become an ISA millionaire
Nevertheless, Stocks and Shares ISAs can work well as part of your retirement savings planning, alongside other vehicles such as Pension Schemes. You’ve probably heard about the increasing list of investors declaring themselves to be ISA millionaires, for example. By investing no more than the maximum allowances each year into Stocks and Shares ISAs, some investors have invested their way to funds of at least £1m, which strikes me as a fund large enough to provide a decent financial retirement alongside the State Pension.
And it’s not necessary to invest in racy, high-risk shares to achieve decent returns. In fact, you probably don’t have to look beyond the firms in the FTSE 100, which contains the UK’s largest public limited companies as measured by their market capitalisations.
Indeed, one popular strategy is to forget about chasing capital gains from rising share prices altogether and to focus on locking in decent income from dividends instead. By constantly reinvesting dividends, you can compound your investments within the Stocks and Shares ISA. And if you’ve chosen your investments well, capital appreciation from rising share prices could ‘take care of itself’.
Avoiding cyclicals and what I would buy
To me, the best dividends come from firms that have strong trading niches in markets with a minimum amount of cyclicality. So, for a long-term holding period, I’d forget about the big dividend yields we often see from firms operating in highly cyclical sectors, such as banking, house building, retail and others. Because of the ebb and flow of the macroeconomy, we could see profits, share prices and dividends cycling up and down with those types of firms, which could make it hard to achieve a decent overall return in the long run.
Instead, I’d target companies in sectors such as fast-moving, branded consumer goods, tobacco, utilities and others. Such firms tend to experience steady demand for their products and services whatever the economic weather, which often leads to stable incoming cash flows and shareholder dividends.
Finally, as well as looking for big dividend yields, I’d also consider smaller yields if the dividends are growing each year at a decent rate. In such cases, we often see decent share-price growth over time too, which could really boost your returns.
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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.