Regularly investing small sums in a Stocks and Shares ISA each day can build enormous wealth in the long run. In fact, just £5 a day can eventually lead to a chunky £13,600 annual income, even when starting at the age of 40. And best of all, by using an ISA, capital gains and dividend taxes are completely out of sight. Here's how.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
No time to waste
When it comes to investing, starting as early as possible is critical. That's because most wealth created in the stock market comes from compounding returns. And the longer they're left to run, the bigger a portfolio can become.
Obviously, the more money investors have to start with, the better. But let's assume I've just turned 40 and have nothing in the bank. I'm planning to retire at 66 and have just £5 a day to spare. That's roughly the equivalent of £1,825 a year. However, since I can't ignore inflation, I'm also going to increase my daily contributions by 3% every year over the 26-year period.
That means after 26 years I'd have injected a total of £70,361. But by matching the FTSE 250's long-term average annualised return of 11% with an index fund, my portfolio could actually be worth just shy of £340,000!
If I were to withdraw just 4% of that each year, this portfolio would generate a passive income of £13,600 a year - all tax-free.
Risk and return
Having £340,000 from investing just £5 a day is undoubtedly exciting. But it's important to keep expectations in check. For starters, this is based on the assumption that the FTSE 250 will continue to deliver its long-term average returns moving forward. Sadly, that's not guaranteed. Looking back at the last decade makes this perfectly apparent, where total returns have actually been closer to just 5%.
Therefore, if double-digit gains are the goal, picking individual stocks could be the wiser strategy. Building a custom portfolio requires far more effort, as does finding high-quality shares to buy. Simply snapping up shares in the most popular stocks doesn't necessarily end well - just take a look at Lloyds (LSE:LLOY).
As one of the UK's largest banks, Lloyds shares are among the most popular across the London Stock Exchange. Yet despite the critical role it plays in the British economy, the bank's been a pretty terrible investment over the last 20 years, falling by more than 75%. And that's even after taking dividends into account.
To the firm's credit, the higher interest environment presents a favourable tailwind for growing interest income in the future. Even with the Bank of England executing the first rate cut since inflation surged this month, Lloyds may continue to benefit as higher debt affordability drives up demand.
However, I'm more convinced by other businesses with far better track records in creating value for investors. So I'd focus my efforts on discovering the opportunities that are seemingly going unnoticed. By investing in these enterprises while remaining sufficiently diversified, the added risk of stock picking can be managed without interrupting returns.