Building ups savings of £1m in a Cash ISA is pretty hard. Even if you’re doing all the right things, the low interest rates on cash savings mean that you’re likely to fail.
In this article I’ll explain why I’d avoid cash for long-term savings and aim to make a million from the stock market.
The numbers don’t add up
At the time of writing, the best instant access Cash ISA savings rate I can find is 1.35%. If you saved £500 each month at that rate, it would take you 87 years to build a £1m fund.
If you chose to lock your cash into a five-year fixed rate ISA, then you could earn 2.03%. But even at that rate, my sums show that you’d need nearly 73 years to reach £1m.
For people on average incomes, the numbers just don’t add up. Unless interest rates rise, you’re unlikely ever to be able to save £1m in a Cash ISA.
What I’d do instead
The tax-free status of ISA accounts means that over a lifetime of saving or investing, we can avoid thousands of pounds in tax. So the first thing I’d suggest for new investors is that you open a Stocks and Shares ISA.
All capital gains and income received in such an ISA are tax free — just like a Cash ISA. Your annual ISA allowance of £20,000 can be applied either type of product or split between the two. Just make sure your total contributions don’t exceed the limit each year.
Getting started with stocks
I believe the stock market is the best way for the majority of people to build a nest egg. But I think it’s important to structure your investments to reduce the risk of permanent losses.
The solution that’s recommended by US billionaire Warren Buffett is to put at 90% of your cash into a low-cost index tracker fund. In the UK, I’d recommend a FTSE 100 tracker fund.
Index trackers have two great advantages, in my opinion. The first is that they are normally the cheapest funds you’ll find in which to invest. Management fees can eat into your returns, so this is good news.
The second advantage is that history suggests the market will always recover from a crash. That’s not always true for individual companies or actively-managed funds. For example, many investors have suffered big losses recently due to the liquidation of Neil Woodford’s funds.
Make £1m before you retire
According to research carried out by Barclays, the UK stock market has generated an average annual return of about 8% over the last 100 years.
If you invest £500 per month at this rate, it would take about 33 years to reach £1m. So if you started at age 25, you could have a £1m stock market fund by age 58 — about nine years before you reach State Pension age.
The final 10%
What about the remaining 10% of your cash? If you’re interested in investing and are happy to spend some time researching stocks, then I’d consider investing this money directly in a handful of growth stocks.
I’d focus on companies that are profitable, generate cash and have an easy-to-understand business model. If your efforts prove successful over a number of years, then you can always increase your allocation of cash to growth stocks. This could help you to hit £1m much sooner than you’d expect.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. 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.