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At first glance, converting annual ISA contributions of £20,000 into a portfolio worth £1 million might seem almost impossible in a typical working lifetime.
However, I think the numbers I’ll share with you here tell us that for an investor using their full ISA allowance each year, building a £1m portfolio may be a reasonable goal.
Later this week, we’ll be sharing some investing insights from Stockopedia subscribers who are already ISA millionaires. But in this piece, I’m going to start from first principles by explaining how long it might take to build a £1m ISA from scratch, based on various possible rates of return.
I’ll also explain some of the headwinds that can hold back portfolio growth and consider how they might be managed to reduce their impact.
First, a quick reminder of the ISA rules:
In each tax year, you can invest up to £20,000 per year in an ISA
This allowance can’t be rolled over or transferred
You do not pay income or capital gains tax on investments in an ISA
(For a great comparison of the benefits of ISAs and SIPPs, take a look at Megan’s recent piece)
According to the Credit Suisse Global Investment Returns Yearbook 2023, UK equities provided an average annual return of 9.1% between 1900 and 2022. After adjusting for inflation, this figure fell to 5.3%.
With these figures in mind, I’ve modelled ISA portfolio growth based on annual returns of 4%, 7% and 10%. I’ve opted for a period of 25 years, with some intermediate stops along the way.
In this initial model, I’ll assume that portfolios are fully invested at all times and have zero costs. I’ll then separately consider the impact of costs on potential returns.
Here’s how an ISA portfolio could rise in value, based on an annual investment of £20,000 and no withdrawals:
Return*/Period | 10 years | 20 years | 25 years |
4% annual return | £240,112 | £595,562 | £832,918 |
7% annual return | £276,329 | £819,910 | £1,264,981 |
10% annual return | £318,748 | £1,145,500 | £1,966,941 |
*nominal return, including inflation
With a 7% annual return, my model ISA crosses the £1m threshold in year 23. With a 10% annual return, it’s year 19.
The impact of compounding returns at higher rates becomes much clearer when we look at these results graphically:
Compounding simply means reinvesting past profits to generate future returns. This can apply to corporate returns as well as personal investments – I considered this topic in my recent Warren Buffett screen.
For the first 10 years or so, compounding doesn’t seem to do much. But after that, the gains start to snowball. The value of the 7% return model portfolio rises by £566,000 between year 15 and year 23, despite only receiving £180,000 of contributions during this time.
I mentioned earlier that the assumptions behind these modelled figures aren’t entirely realistic. The reasons for this can be broken down into three categories:
Sequencing risk
Cash & dividends
Costs
Long-term average rates of returns are rarely seen in real life. Instead, investments tend to deliver uneven patterns of gains, plus occasional losses.
This gives rise to sequencing risk. This is the risk that the patterns of return achieved on an investment will result in a lower overall return than expected at a specific time in the future, such as retirement.
For example, this chart shows the annual total return delivered by the FTSE 100 and FTSE 250 indices over the last decade:
Stock market history tells us that crashes often provide long-term investors with good buying opportunities.
The flipside of this is that investors planning to crystallise their investments at a fixed point in the future could see their portfolio plummet in value at just the wrong time.
Cash: It’s unlikely that any direct equity investor will be 100% invested all of the time. The mechanics of share dealing and dividends mean that most investors will hold cash in their portfolios sometimes.
In a rising market, cash tends to act as a drag on a portfolio, while in a falling market it’s supportive. Over many years, my assumption is that these factors will generally average out.
I think it’s more important to focus on how cash fits into the framework of your investment strategy.
For example, one simple approach to cash management is to adopt a pound-cost averaging strategy. This means ignoring market movements and buying additional stocks whenever the portfolio has sufficient cash to do so.
Pound-cost averaging is a strategy that’s well-aligned with the adage that “it’s time in the market that counts, not timing the market”.
However, having money available during periods of volatility can open up superior buying opportunities. These may boost long-term returns.
Dividends: many portfolios will receive dividend payments, even if they’re not following an income strategy.
My model assumes that all dividends are reinvested instantly. Of course, this isn’t necessarily practical. In many cases, we need to wait for sufficient dividend cash to accumulate to justify the transactional costs of buying more shares.
Conclusion: Managing cash and dividends may have a positive or negative impact on portfolio returns over time. I don’t think there’s any accurate way to predict this, so I think energy is better spent on stock selection and strategy.
When we look at our investment costs, it’s common to consider them on a year-by-year basis, in isolation. Doing this, even above-average costs may not seem so bad.
Unfortunately, this viewpoint can dramatically understate the potential impact of trading costs. This is especially true for portfolios with high turnover.
The reason for this is that compounding also works in reverse. Money spent on costs is money that can’t be invested.
Looking back at my modelled results, a cost of £250 in year five would translate into almost £1,000 of lost value by year 25 (7% annual return).
When we consider the impact of compounding, we get a fresh understanding of the importance of managing portfolio costs. This chart shows the impact of different cost levels over 25 years, applied to the 7% return model portfolio I described above:
Here’s how different levels of costs affect the value of a portfolio with 7% gross annual returns over time:
7% return portfolio | 10 years | 20 years | 25 years |
0% costs | £276,329 | £819,910 | £1,264,981 |
0.25% costs | £273,087 | £797,871 | £1,220,486 |
0.5% costs | £269.888 | £776,506 | £1,177,754 |
0.75% costs | £266.731 | £755,793 | £1,136,711 |
For anyone trading shares inside an ISA wrapper, costs generally fall into two categories:
Stamp Duty
Service fees: dealing costs and custody charges
Stamp Duty: Stamp Duty of 0.5% is charged on the value of all share purchases, except for most AIM stocks and a few other exclusions.
Mark recently highlighted research suggesting that the average private investor may turnover 75% of their portfolio yearly. For investors fitting this profile, my sums suggest the impact of Stamp Duty could be very significant over time.
In the chart above, the 0.25% cost curve effectively models the cumulative impact of Stamp Duty for a portfolio of Main Market shares with 50% annual turnover.
The other curves simulate higher levels of costs, either from turnover or fees.
Fees: the good news is that dealing costs and custody charges generally fall as a percentage as portfolio value increases.
For example, Hargreaves Lansdown (LON:HL.) has a 0.45% custody charge for shares held in its Stocks & Shares ISA, but this is capped at £45 per year. So for any portfolio over £10,000, the charge starts to fall in percentage terms.
Similarly, a typical £10 dealing charge is 1% of a £1,000 share purchase, but only 0.1% of a £10k buy.
Conclusion: The returns on my modelled portfolios suggest that it’s worth accepting some additional costs in pursuit of higher return. But I think it’s clear that investors can also make useful long-term gains by simply minimising costs.
I can’t be sure that the 9% average return seen since 1900 will be representative of the next few decades. But even with more modest single-digit annual rates of return, I think we can still be confident that the stock market will continue to provide substantial compound growth opportunities for ISA investors.
I strongly believe that the best time to start building a long-term portfolio is always right now. The near-term future is unpredictable, but I'm confident good companies will continue to prosper and expand over the coming decades.
For more inspiration and some valuable insights into the real-world strategies and used by investors with high-value ISA portfolios, stay tuned for our subscriber interviews later this week.
About Roland Head
I'm an investment writer and analyst, with a particular focus on systematic investing and dividends. I look for quality stocks with above-average returns, strong cash generation, and attractive valuations - always with dividends.
In my earlier life, I worked as an systems engineer in telecoms and IT. The quantitative, rules-based approach required for this kind of work suits me and has certainly influenced my investing style. I also learned a lot from seeing the tech bubble deflate in 2000/1, when I was working for a large and now defunct telecoms group.
Disclaimer - This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.
Hello Roland, this assumes you will be able to contribute £20,000 a year in the future, I think there is some doubt about that, ISAs could be capped also. £1m now is a decent amount of money but in 20 years will it be?
Do your growth figures take into account the spread on shares? Which can be wide on UK stocks. US shares a lot better but you then there are forex fees and witholding tax issues on dividends. Inflation is likely to be higher than it has been in the last 20 years.
I agree, if you have not got an ISA, do it now before the tax year ends.
HL are expensive, not all their fees are capped, funds are 0.45% per annum, in ISAs. Forex fee is 1%. You can't hold foreign currencies within an ISA.
Hello Rusty2,
I agree that tax rules can always change and may do so, thanks for pointing this out.
Inflation does mean that the value of £1m will be less in the future, but I think it will still be a worthwhile amount.
For what it's worth, I estimate that £1m in 25 years would be worth about £375k, based on a fixed 4% inflation rate.
Spreads/FX: I consider the impact of dealing spreads but opted to ignore this as there are many possible outcomes, depending on the strategy being followed.
For most FTSE 350 stocks, spreads are very low, often minimal. Small caps and other niche stocks can incur large spreads, but even here, they're likely to be less significant over long holding periods.
For foreign shares, there are too many variables for me to consider here - they can have a positive or negative impact over time. As always, much depends on the strategy being followed.
Hargreaves Lansdown (LON:HL.) charges: according to the website, HL's 0.45% custody charge for shares in an ISA is capped at £45/yr.
Custody charges for funds in an ISA appear to be far higher - fees operate on a sliding scale up to £2m, in addition to any fund charges...
Regards,
Roland
It's actually quite difficult for most people to invest 20K per year. I've found from experience you get times in your life you can hit that figure, then other times it might be 5K or whatever is surplus. Problems you get with ISAs is the flexibility if you need a lump sum that is income tax free you draw from your ISA to say buy a car or deposit on a house etc. So to hit your million you need to set an intial fund balance that is lower then apply a compounded rate of growth from that figure. Set this to £100K with average compounded growth of 10% is achieveable you can easily get 5% just from dividends alone, you hit £1 million in 25 years without additional funding in the ISA during those 25 years. Discipline and money management is all you need because you don't need to be 100% fully invested all of the time (the FTSE is a very range bound index). When the market is topping you take half off of the table, don't get greedy.
Articles like this make it seem much easier than it is in practise to run an Stock Picking ISA that makes any profit never mind a fortune.I belong to a Signet group of experienced investors in which every individual picks their no1 share to buy at any moment and the record of most of us is not that good .I do not read newpaper/magazine share tipsters anymore one reason being that i found their track record was not very good either.
Of course we all have good winners but how many turn into long term multibaggers ?And most of us have a disaster here and there.To build a really successful ISA one needs a multibagger or 2 and to avoid disasters.
On a personal level since QE I have put 20% of my ISA into an Index Linked Inflation Gilt Fund and for 12 years the Fund was going up every year and then in 2022 every Index Linked Gilt Fund fell from 40% to 70% .Of course the Gilt Funds should recover but as the Silicon Bank management found out even the supposedly safest investments are never as safe as one thinks.
The power of ISA's can't be overemphasized, even if you can only invest a fraction of the annual allowance (Like me), they are still worth having, as so far as I can tell the difference in charges between an ISA and a plain-Jane execution only broker account are minimal, so you might as well get an ISA and avoid the tax burden.
However I have read somewhere- elsewhere on Stocko perhaps?- that despite being around for decades ISA's/ TESSA's have created less millionaires than either the national lottery or Premium Bonds. From this I infer that most holders struggle to both invest the maximum allowance AND make sound investment decisions, which would be the twin drivers of accumulating a £1,000,000 portfolio.
On a gloomy note, irrespective of ISA's in a few years we will probably have a lot more "Millionaires" as rising house prices seem to be as certain as death and taxes, the trouble will be how to realise the cash- when you sell your home where will you live? I also wonder if those of us who still have 30+ years of work before we can claim state pension will end up banking million-pound salaries due to inflation, which begs the question; what would be the new ISA target? A billion pound return seems unimaginable but if the average wage hits one million what else is there to aim for?
Or try just putting it into a smaller-scale private equity trust, like Oakley Capital Investments (LON:OCI) , which is a basket of companies, and before you worry about the fees, just look at the 1,5 and 10-year total return. Advising family members, I can sleep nights using that, CT Private Equity Trust (LON:CTPE) and VinaCapital Vietnam Opportunity Fund (LON:VOF). Noticed the lack of British PLCs supplying British customers?:)
I agree that it is worth putting as much as you can in an ISA each year AND using dividend reinvestment. Costs are important. I have used Halifax Share Dealing since self select ISA’s started - low annual fee (not a percentage of your investment), low dealing costs, an automatic and very cheap dividend reinvestment option, and simple tools for regular investment and price locking if you want to use them.
Of course, stock selection matters.
For those looking for ideas, I suggest investment companies at huge discounts to their NAV where the managers have skin in the game eg North Atlantic Smaller Companies Investment Trust (LON:NAS) , Caledonia Investments (LON:CLDN) . (I have held both for many years)
It’s a marathon, not a sprint!
Very good analysis. I suspect I may one day reach my ambition of being a millionaire however by then this will be not enough to actually retire on!
Great article Roland and I love the comments from the community. I have highs and lows with my ISA too like Silver Moon. . Saving 20k every year and positive stock picking is not a easy as it sounds. And just when I am seeing positive results after a rubbish 2022 the banks hit us with a problem! I have been trying very hard this year and I have had a stroke luck saving the allowance this year and next.
*Past performance is no indicator of future performance. Performance returns are based on hypothetical scenarios and do not represent an actual investment.
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I love your take Roland, I've been trying so hard but it's like trying to field wetted bars of soap.