The government’s decision to increase the annual Stocks and Shares ISA allowance to £20,000 was a boon for savers. That’s a substantial sum of money to be able to invest on a tax-free basis. Indeed, I believe if it’s invested correctly, this lump sum could help you become a millionaire investor.
The road to a million
I believe the best way to invest your money in a Stocks and Shares ISA is with funds and investment trusts.
Picking stocks is a tough business. Even the professionals regularly get it wrong. If you have £20,000 to work with, it might be better to avoid picking stocks altogether and pick collective investment vehicles instead. These will offer better diversification with much less time and effort required on your part.
According to my calculations, to be able to turn £20,000 into £1m, an investor will need to achieve an annual rate of return of 10% for 40 years. There are a variety of different investments you can use to hit this target.
For example, the FTSE 250 has produced an average annual return of around 9% for investors over the past decade. So you could buy the FTSE 250 and leave it at that. At an annual rate of 9%, I estimate it would take 45 years to turn £20k into a million.
However, I think a combination of funds and trusts would be a better investment strategy.
For a start, I would use a low-cost income index tracker fund, such as Vanguard’s FTSE UK Equity Income Index Fund, to build the foundations of my portfolio.
Over the past decade, this fund has returned around 10% per annum by owning the UK Equity Index benchmark. It currently holds 128 of the UK’s top income stocks. I would allocate around a third of my portfolio to this investment.
Another fund I would buy is a low-cost S&P 500 index tracker. The S&P 500 is an American index, but because the US equity market is by far the largest in the world, I think every investor should have some exposure to this leading stock market. It has returned around 9% per annum for the past 100 years and would be a perfect complement to the UK equity income investment in an ISA portfolio. This would be another one-third allocation.
My third and final pick would be a small-cap focused investment trust. According to fund rating agency Morningstar, over the past decade the Morningstar IT UK Smaller Companies index has produced an annualised return of 14.7%.
This market-beating performance is highly impressive, but the one downside of small-cap investing is volatility. That’s why I think the holding should be limited to just a third of a Stocks and Shares ISA portfolio.
The bottom line
So, that’s how I would invest £20,000 in a Stocks and Shares ISA today. As my figures above show, it looks as these three investments have the potential to achieve the double-digit returns required to create a fund worth £1m.
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Rupert Hargreaves owns the Vanguard FTSE U.K. Equity Income Index Fund. 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.