I happen to think that opening a Stocks and Shares ISA is one of the best financial decisions an investor can make. Stocks and Shares ISAs are operated like any traditional dealing account. The one key difference is that they come with added tax benefits.
Specifically, any income or capital gains an investor generates on assets held within one of these wrappers does not attract tax. Investors do not even need to declare ISAs on their tax return.
And with the annual ISA allowance set at £20k, I think there’s little if any reason for an investor to open a traditional dealing account. Why pay the extra tax when you don’t need to?
Stocks and shares ISA benefits
Without tax obligations, it is possible to build wealth at a faster rate. For example, a higher-rate taxpayer will have to pay a tax rate of 32.5% on dividends and 20% on capital gains. That means for every £100 of income, £32.50p will go to the taxman.
Roughly speaking, this suggests a third of any income an investor receives on assets owned outside of a Stocks and Shares ISA will disappear. For example, the FTSE All-Share currently supports a dividend yield of around 4%. My figures suggest this falls to 2.7% after-tax.
Over the long term, this could have a massive impact on returns. An investment of £1,000 growing at a rate of 4% per annum could become £4,940 after 40 years of saving, according to my numbers. However, the same investment of £1,000, growing at a rate of 2.7% per annum would be worth just £2,941 after four decades. That’s a difference of £1,999.
Investing for the future
I think these pictures illustrate precisely why an investor would benefit from using a Stocks and Shares ISA.
Choosing the right investments is the next part. I’m using a combination of high-quality blue-chip stocks, active investment funds and passive trackers to provide the best combination of income and growth.
Consumer goods giant Unilever and insurer Admiral feature in my blue-chip portfolio. I believe these companies have substantial competitive advantages that should allow them to provide impressive returns for shareholders in the medium term.
At the same time, I own the Mercantile Investment Trust. This gives me exposure to a broad selection of mid-cap stocks. These can produce higher capital returns than blue-chips in the long run.
Finally, I own a FTSE All-Share index tracker. This fund is designed to replicate the underlying index. There are benefits and drawbacks to this approach, but overall, I think the passive tracker fund is a great way to replicate the performance of the index with low costs.
I think the combination of investments above can provide an 8% to 10% annual return in the long run. Based on this projection, I reckon it will take me just 17 years to build million-pound Stocks and Shares ISA. That’s assuming I use up the £20k ISA allowance every year.
Rupert Hargreaves owns shares in Mercantile Inv Trust, Admiral Group and Unilever. The Motley Fool UK has recommended Admiral Group and Unilever. 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.