ISAs, or Individual Savings Accounts, are a valuable shield against tax for UK investors. You can currently put away up to £20,000 a year in ISAs, and any income or investment gains are free from income tax or capital gains tax – no matter how much money you make.
ISAs are available either as Cash, which is like having a tax-free bank or building society account, or Stocks & Shares where your money can be invested in a variety of assets in search of higher returns – albeit you could face losses as well as gains, especially in the short term.
Over time you can build up a substantial amount of money in ISAs and shelter it from tax. Since the advent of ISAs and their forerunners PEPs in 1989, an investor could have contributed over £375,000 to these tax efficient allowances by utilising the maximum available each tax year. If someone was able to do so, they would have needed a growth rate of about 5.8% a year to reach £1m today. This would have been achievable with a diverse portfolio rather than taking a high level of risk.
There are now thousands of ‘ISA millionaires’ in the UK who have built up seven-figure pots – and there’s no reason why more can’t join them.
The different types of ISA account
These are the different types of ISA; think about which appeals to your financial goals:
- Cash ISA – a savings account. Store up to £20,000 each tax year with no tax on interest you earn
- Stocks & Shares ISA – an investment account. Invest up to £20,000 with tax-free returns
- Lifetime ISAs – specifically for those saving for a home or retirement fund, allowing you to save up to £4,000 a year. The government pays you £1 for every £4 you save.
- Junior ISAs – A long-term savings account for children, set up by a parent or guardian. Only the account holder (the child) can withdraw funds once they’re 18.
You don’t have to be a high roller to be part of the elite club of ISA millionaires – and you can have more than one type of ISA at a time. Just be sure to only have one provider of each for contributions in a particular tax year ending on the 5th April. That means your annual tax-free allowance of £20,000 can be divided in any proportion you like between them.
How to become an ISA millionaire
With a bit of research or professional advice when needed, an investment ISA can be a stress-free way to earn in the background. Here are the ways in which investors have been able to maximise the value of their ISA wealth.
1. Use investment ISAs & the stock market to your advantage
ISA millionaires reinvest their gains and dividends regularly and have relatively little in cash - the average currently being 6.5% cash within Charles Stanley millionaire ISA accounts. It will likely take far longer to become an ISA millionaire if you leave your money in cash as interest rates are generally well below the rate of inflation – the rate at which the cost-of-living rises. This is why many ISA holders turn to the stock market in search of better returns.
Some people are naturally risk-averse and find it difficult to take risk with their money. However, broadly speaking, the longer you can remain invested the greater tolerance of risk you are able to have and the higher exposure to more volatile areas is appropriate. The acceptance of a higher risk strategy is necessary to generate higher returns – but it does come at the expense of greater short-term swings in the value of your capital.
If you manage 5% annual investment growth you would hit the million-pound mark in 25 years with £20,000 invested each year. However, with a higher return of 7%, it would only take 21 years. Achieving a 2% return would stretch the necessary time to 34 years, which illustrates why long-term investors avoid holding too much cash. Low returns are a severe impediment to meeting retirement or other goals.
Going forward, stock market returns could be lower than they have been historically. Yet the likelihood is that over the longer term the stock market represents an excellent way to generate an inflation-beating return on your money.
Contributing money at regular intervals, say once a month, rather than a lump sum, is another way to take the worries out of investing. The strategy can even turn market volatility to your advantage if prices fall in the short term but rise over the long term. There’s more on this in my article on regular investing here.
2. Maximise ISA contributions - and start early
Most ISA millionaires get rich slowly by patiently staying the course, at Charles Stanley Direct we have clients who are still investing well into their 70s.
Most also contribute the maximum amount allowed each tax year to their ISA. The size of any portfolio is a function of two things: how much is put in and the return generated. With many demands on our money, it may not be realistic for many people to use their full ISA allowance each year, but the more you save and the earlier you do so the better.
Putting aside a small amount each month can snowball into a sizable sum if you get the ingredients right. Those who contributed to a Junior ISA account (JISA) throughout childhood will understand this well. The important thing is getting started, and the earlier you do the more time your chosen investments have to grow.
- Take two investors, both investing for retirement in 40 years' time:
- One starts investing £100 per month right away, the other does nothing for 20 years, but then invests £300 per month
- The investments chosen both grow by 5% per year after charges
- At retirement, the first investor will have spent £48,000 on their monthly contributions and the second investor £72,000. Yet despite having spent much less, the first investor's retirement pot would be worth £152,602 compared to the second investor's £123,310
By starting early, you give yourself the best chance of harnessing the long-term growth of stock markets.
3. Get your investment approach and risk level right
It will take a long time to become an ISA millionaire – unless you are exceptionally lucky or insightful and pinpoint very lucrative individual shares that rocket in value. Yet having a considerable amount invested in a single share means your success rests on the fortunes of a single company, so it means a very high level of risk. You could face losses that are impossible to recover from if you are unfortunate.
Most people will rightly decide against such a strategy, though for those prepared to dedicate the time to thoroughly researching companies, it can sometimes be fruitful. What tends to unite successful private investors in shares is the enjoyment of the challenge of navigating a profitable path through markets and taking a keen interest in researching investments. This tends to take a lot of time and dedication. Fortunately, for those more ‘hands off’ or time-constrained, there are convenient ways to spread the risk and still generate decent returns from your ISA.
Many new investors ask me: ‘what’s the safest investment?’, to which the answer is not one, but many. In other words: diversification. Funds allow you to spread your money among lots of different shares at the same time, meaning the risk is spread out. Picking winning funds is not straightforward, however, but tends to be easier and less hands-on than researching individual company shares.
Some of the fund sectors that have delivered for investors over the past decade include technology, biotech and smaller companies. Using investment trusts can also help boost returns. These often outperform fund equivalents because they can use gearing – or borrowing to invest. They can be riskier, though.
4. Be patient and disciplined with your ISA funds
Today’s ISA millionaires have seen many booms and busts but being too reactionary and trading in and out of the stock market over the short term can be unwise – even if political or economic reasons seem compelling. Not only are outcomes unpredictable, but so are their effects on financial markets.
It’s usually best to stick out tough times, stay invested and keep adding to your investments. As a patient investor with a long-term horizon time is on your side. Leaving money untouched and reinvesting returns is crucial to allow the magic of compound interest – earning interest on your interest – to take effect. There’s more on how compounding works here.
Very few people can time markets, and even fewer consistently. Clearly, there are severe corrections in the market from time to time that result in the loss of capital, and it is best to try and time your new investments to coincide with dips in the market, but this is easier said than done. In the long run, committing to riding out the peaks and troughs tends to provide a better result. Where you do take profits, keep your money in the ISA rather than withdrawing it to preserve that part of the ISA allowance you have built up.
Does the right ISA investment strategy involve shares?
There is more than one way to invest successfully, and ISA millionaires do differ in their approach. It’s common to invest in individual shares. While some do so actively others use a buy and hold approach for years or decades. Yet it’s also common for people to outsource some of the heavy lifting to fund managers, especially through investment trusts that offer diversification within a certain region or asset class, and often some ‘gearing’ (borrowing to invest) to increase risk and enhance returns.
Overall, among Charles Stanley millionaire ISA accounts there is a bias to individual shares at 64% versus funds (including investment trusts and ETFs) at 36%. Geographic exposure also varies. The UK makes up 72% of portfolios on average among Charles Stanley Direct ISA millionaires, versus 28% overseas.
Although the millionaires display a clear home bias, and may have missed some good returns from US stocks over the past decade, they have delivered very respectable returns from investing in UK blue chips and reinvesting dividends, as well as through harnessing more dynamic UK small and medium-sized companies. Over the long term these have typically outperformed the larger stalwarts.
With the end of the financial year approaching, have you taken advantage of the tax allowances available to you? Find out more about how you can save tax every year with an ISA and other tax shelters.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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