An investor can shelter £11,520 from tax this year in an ISA, with the Government committing to increase this amount in line with inflation in future years.
Assuming a 2.5 per cent inflation rate, the man in the street will be able to generate £1m in just 29 years, which Tom Stevenson (pictured), investment director at Fidelity Worldwide, says highlights the power of compounding interest. “Many of us underestimate the power of an ISA,” he said. “It may not sound very exciting, but this is one of the most generous tax breaks available to savers in the UK.”
“Investing the full amount each year – or as much of that as you can – can be the most powerful way to build up your savings.”
“Remember that as well as sheltering your initial investment from the tax man, you’re also protecting the returns you make.”
“Choose your funds wisely, and those returns could be very significant over time.”
The returns Fidelity assumes are relatively modest at just 5 per cent, and are in the region a balanced portfolio of stocks, bonds and alternatives can be expected to achieve over the longer term.
Over the last 20 years, the FTSE All Share has averaged 7.03 per cent a year, according to our data. We can only track returns on the iBoxx gilts and corporate bond indices back 15 years, but over that time they have returned 4.35 per cent and 4.5 per cent a year respectively.
Shares have made 5.07 per cent a year over that time.
There is, of course, no guarantee these patterns will be repeated in future years, but the level of returns on the index means that holding a simple passive fund would be enough to make an investor a millionaire.
Source: FE Analytics
Most investors will use a variety of different funds in their ISA and carry out their asset allocation themselves.
However, multi-asset funds offer a way in which investors can get this diversification without having to micro-manage their holdings themselves.
Few single funds have a track record as long as 29 years, and FE data is patchier back in the dark days before the internet. However, there are 151 funds in the four Mixed Investment sectors with a 15-year track record.
Our data shows that 41 of those funds have made more than 5 per cent a year over that time, with some generating significantly higher returns.
The best returns over that period have come from Neptune Balanced, which has made 9.26 per cent a year, and Ecclesiastical Higher Income which has made 8.48 per cent a year.
CF Miton Special Situations has made 8.45 per cent a year and McInroy & Wood Balanced 8.13 per cent.
Source: FE Analytics
Ten of the funds, including those mentioned, have returned more than the FTSE All Share over that time, showing the benefits of being able to shift into lower-risk assets such as cash and bonds when markets sell off.
A greater proportion of the funds have managed to beat that 5 per cent figure than those that invest solely in equities, our data shows.
In the IMA UK All Companies sector, 53 out of the 113 funds with a track record of 15 years or more have made more than 5 per cent a year, while one – Manek Growth – has managed to lose money.
Investors are taking more risk of not hitting this 5 per cent figure in an equity fund, this data suggests, although far greater returns are available in shares.
GAM UK Diversified has returned 12.84 per cent over that time period and Fidelity Special Situations 12.56 per cent. Schroder Recovery has made 12.47 per cent and Cavendish Opportunities 12 per cent.
Source: FE Analytics
Stevenson says this data highlights three things savers should do to increase the chances of becoming an ISA millionaire: firstly, start early.
“To make the most from your savings, it’s important to start saving as soon as you can,” he said.
“This gives your money as much time as possible to grow in the market in the long-run, thanks to the magic of compounding – where the returns on your investment can generate further returns.”
“Even if you’re not yet able to invest your full ISA allowance each year, every little helps, and getting in early is important.”
Secondly, he says investors should save as much as they can afford.
“There are always more exciting things to spend your money on, but an ISA is a really good way of protecting your savings from the tax man,” he said.
“The ISA is a use-it-or-lose-it tax break – so, unlike with a pension, you can’t use any previous years’ allowance retrospectively.”
Thirdly, and most controversially, Stevenson says investors should invest in funds and not cash.
“Many of us first assume that cash is the safest option when it comes to investing our savings. While this is partly true – you won’t get the ups and downs in cash savings that you might with the stock market, and cash is ‘liquid’ so you can access it more flexibly – leaving your money in cash risks a big erosion to your savings pot over time.”
“With interest rates at record lows, the returns on high street cash savings accounts are extremely limited.”
“Investing in individual stocks or bonds comes with significant risks,” he added. “Tie all of your money up in one company’s stock, and you could lose everything overnight in the worst-case scenario.”
“The best route to building up your savings pot (and managing your risks) is investing through funds, which give you access to the market without tying your fate to a single security.”
“As you reach your savings goals through investing in your ISA over time, it’s even more important to diversify.”
FE Trustnet will be analysing some of your ISA picks this weekend. Stay logged in for more ISA ideas in the coming weeks.
