David Prosser looks at how making the most of your annual tax-free savings allowance could make you a millionaire.
Here’s a thought to cheer you up this miserable winter: in only a few years’ time, you could be a millionaire, just from making good use of the annual tax-free savings allowance that the Government offers everyone to encourage them to save more. Indeed, several hundred people have already built up individual savings accounts (ISAs) worth more than £1m according to research published by the Daily Telegraph last year.
So how long will it take? Well, analysis from Fidelity Investments suggests that starting from scratch today, you could be an ISA millionaire in less than three decades, even based on some relatively conservative assumptions. Its forecast assumes you invest the maximum amount possible within your ISA each year and that the allowance increases by 2 per cent annually; you’ll then need to earn an average annual return of 5 per cent, assuming annual charges of around 1 per cent. Using this model, it would take 27 years and 10 months to go from zero to £1m, Fidelity says.
Short cuts to the £1m mark
The good news is that you may not need to wait anywhere near that long to hit the £1m target. For one thing, this year the ISA allowance will rise by substantially more than 2 per cent. On 6 April, it rises from the current £15,240 to a whacking £20,000 – that offers a real opportunity to put more into tax-free savings than ever before.
Remember too that couples get their own ISA allowances, which effectively doubles the amount they can invest each year. Those couples who both take advantage of their ISA allowances will break through the £1m mark in half the time.
Moreover, many investors will hope to earn more than an average of 4 per cent after charges. If they’re successful, they’ll reach £1m significantly more rapidly, particularly after taking into account the effect of compound interest.
It’s the underlying investment that matters
However, the key factor in this race to a £1m will be the underlying investments in your ISAs; remember, ISAs aren’t investments in their own right – rather they’re shelters within which you can hold a broad range of assets in order to insulate them from income tax and capital gains tax charges. On large portfolios of investments, the tax savings will be substantial, but you’ll need to pick assets that perform strongly and consistently.
In which case, investment companies have a good claim to a big role in your ISA strategy. They provide a practical solution for investors, offering both lump-sum investment and regular savings options, and are all ISA-qualifying holdings. They also offer exposure to a broad range of assets, including the stock market, which has tended to produce higher long-term returns than other investments, and is likely to be a central plank of most long-term investors’ strategies.
On performance, research has consistently shown that, in the past at least, investment companies have tended to outperform other types of collective investment fund. This is no guarantee they will continue to do so in the future, but investment companies do offer certain advantages – generally low charges, structural benefits, and the ability to take on gearing, a technique which boosts returns when markets are rising.
You don’t have to use your entire ISA allowance each year to invest in investment companies, but this type of fund does have real benefits, and there’s enough choice to build a diversified portfolio of funds with different appeal. Who knows whether you’ll reach £1m – but it’s not out of the question if you get started sooner rather than later.