Maxing out an ISA with one of the top 28 investment trusts would have made you a millionaire over the past two decades. As stocks & shares ISAs pass the test of time, Nick Green looks at the pros and cons of using them versus cash.
Who wants to be a millionaire? Some canny long-term investors may have seen that dream recently come true, not by phoning a friend but by making a wise choice at the turn of the millennium – and then sticking with it through thick and thin. New data from the Association of Investment Companies (AIC) shows that an investor who used up their full stocks & shares ISA allowance every year from 1999 to 2020 could now have savings totaling over a million, provided they picked one of 28 investment companies (also known as investment trusts).
Furthermore, the top eight investment companies in the list would have returned over £1.5 million over this period, and the best performer, Scottish Mortgage, would have yielded over £2.5 million. In total the investor would have paid in just £246,560 over the 21 years (or an average £11,741 per year, though the figure would start lower and increase over time). This means the investor would have at least quadrupled their money over this time, and with the top performer would have increased it by a multiple of ten.
The top eight performing investment companies by this measure were:
- Scottish Mortgage
- Biotech Growth
- Allianz Technology
- Pacific Horizon
- JPMorgan China Growth & Income
- Edinburgh Worldwide
- Polar Capital Technology
- HgCapital Trust
How to make an ISA million (1999 to 2020)
Of course, investing a quarter of a million pounds to make a million-plus is easier said than done. But would it have been as hard as it sounds? Assuming a few enterprising people actually managed to achieve this, let’s look at what it would have involved.
Take a hypothetical investor in 1999 – we’ll call him Jeremy. First, Jeremy would have had to invest via an investment trust rather than an ordinary stocks & shares portfolio. Not just any investment company would do, either, but one of those identified by the AIC (hindsight is a wonderful thing, but with 28 to choose from his chances of success would be pretty good). Next, the AIC calculations assume that Jeremy uses up his full ISA allowance every year from 1999 to 2020 and ploughs it all into a stocks & shares ISA investing in that company. So how much money does he have to find?
The ISA maximum allowance has changed considerably since ISAs were introduced in 1999. Until 2008 Jeremy could ‘only’ pay in £7,000 a year. Over the following seven years this rose gradually to £15,000 a year, then in 2017 leapt to £20,000 where it has stayed since. Now, most people couldn’t find a spare £7,000 a year to save, much less £20,000. But for the purposes of this example, let’s suppose Jeremy is well-off but not rich, with an income of £60,000. After tax, National Insurance and 5% pension contribution, his take-home pay would be £42,127 a year. Taking £20,000 out of that would be painful, but maybe not completely impractical, depending on how frugally Jeremy can live. It’s the sort of extreme saving made popular by the ‘FIRE’ movement (Financial Independence, Retire Early). Of course, if Jeremy’s income is higher, and/or he is saving with a partner, that sort of figure looks more and more achievable.
Stocks & shares ISAs vs cash ISAs
In any case, the ‘Could I have been a millionaire?’ question is a moot point. The real message of the AIC data is that stocks & shares ISAs (in particular, those using investment trusts) have delivered good long-term returns relative to cash accounts. For comparison, even if one were to invest the full sum of £246,560 at the start (as opposed to drip-feeding it in gradually over 21 years), you’d need a steady interest rate of 7% on your savings to reach a million by 2020. And in order to match the top 8 investment companies in the AIC rankings, you’d need interest rates of a whopping 9%. The last time cash savings rates went over 7% was in 1992, and since 1999 the average has been nearer 3%.
Shares have comfortably beaten cash over a two-decade race, and although past performance is never a guide to future performance, it is an indicator of what can be achieved. Cash savings are to some extent predictable – they will grow in line with the interest rate offered (though that interest rate may well fall or rise). Stocks & shares have a very real chance of losing money, but also greater potential for gain. This is the infamous ‘volatility’, which is essentially the same thing as risk. Investing in more volatile assets means taking on more risk, in exchange for a chance of better growth. For any investor, getting this balancing act right is the Holy Grail.
It’s also worth reflecting that in times of very low interest, such as now, keeping money in cash savings carries a risk of its own, which is that inflation will gradually erode its value. Investing therefore offers savers a chance to protect their money from this weathering effect and have a hope of beating inflation.
Choosing investments to suit your long-term needs
Commenting on the findings, the AIC’s Communications Director Annabel Brodie-Smith said, ‘Whilst it’s always fun to dream of becoming an ISA millionaire and have that “what if” moment, it’s important not to put all your eggs in one basket. No-one can tell which will be the best-performing investments in future and it’s important to have a diversified portfolio which suits your long-term needs.’
Nevertheless, she also drew attention to the fact that half of the investment trusts in their ‘millionaire list’ were in the smaller companies sectors. By their nature, smaller companies have more growth potential, but as assets they can be harder to trade in. Investment companies offer a way to invest in such companies without having to tackle that liquidity problem yourself. Annabel said that this ‘demonstrates the benefits of the investment trust structure for delivering strong returns over the long term’.
Tips for using a stocks & shares ISA
Whether you choose to invest via an investment trust or a portfolio of your own choosing, a stocks & shares ISA always involves more risk than a cash ISA. In the 2019/20 tax year, for example, the average cash ISA received 1.21% in interest, but the average stocks & shares ISA fell by over 13% –almost as bad as the 20% loss seen in the financial crisis of 2008. Our hypothetical saver, Jeremy, would have had to weather both these storms and plenty of smaller ones over the 21 years. The hardest part would have been holding his nerve and continuing to pay in the maximum ISA allowance every year, despite the falling markets. Realistically, only someone with a lot of disposable income would feel able to do this.
So instead of trying to become a millionaire, follow these simple guidelines when considering a stocks & shares ISA:
- Have a time period in mind, preferably five years or more. Investing is a marathon, not a sprint.
- Set a goal, or at least a target. Saving a deposit for a home is a popular one. See our guide on How to save a deposit in 6 years using an ISA. If you don’t have a specific goal in mind, aim for a specific amount by a particular date.
- Invest only excess income, or lump sums you won’t soon need to spend. This should be money you can comfortably forget about for several years.
- Make sure you have enough in cash savings to cover at least two months’ spending before you start to invest.
- Spread your risk. Despite the examples given above, you should aim for a variety of different funds, some of which are low volatility, to provide more stability.
- The longer you’re investing for, the more risk you can afford to take. If your target is 10 or more years away, you can afford to dip into more volatile assets.
- Monitor your ISA’s performance, but don’t panic when it falls (it is when, not if). Similarly, don’t get too happy about sudden gains. Booms and busts are inevitable bumps along the way.
- As you approach your target amount, consider moving your ISA into lower risk assets to reduce the risk of losses in the last few months.
If you’re planning to invest significantly to make the most of your ISA allowance in the years to come, a financial adviser can help you make the best choices, including whether or not to use an investment company.