When it comes to saving for retirement, there’s no question in my mind. A Stocks and Shares ISA is a much better way to build wealth than keeping money in cash.
Over the last 10 years, the FTSE 100 has returned an average of 6% per year to investors. With regular deposits of £1,000 per month, that’s enough to make someone a millionaire after 30 years.
Compound interest
Investing £1,000 per month at 6% per year results in a portfolio worth £1,010,000 after 30 years. That’s much better than the best Cash ISA I can find at the moment, which pays 3% annual interest.
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Someone who put aside £1,000 per month and earned a 3% annual return for 30 years would have £585,000 at the end of the process. That’s a long way short of £1,010,000.
The difference doesn’t seem like much after one year – a 3% return would result in £13,196 and a 6% investment would be worth £13,997. Over time, though, the returns diverge significantly.
This is because of the power of compound interest. Each year, an investor earns a return not only on money they deposit, but also the returns they’ve generated in previous years.
As a result, someone who achieves a 6% gain doesn’t just earn a higher annual return than someone who invests at 3%. They also earn that return on a larger sum.
This is why I think that a Stocks and Shares ISA is the right choice for someone looking to build wealth. The difference in returns really adds up over a long period of time.
Investing risks
It’s important to note, though, that the path to £1,000,000 in a Stocks and Shares ISA is unlikely to be smooth. The level of the stock market goes up and down, sometimes quite dramatically.
The FTSE 100 fell by 11.5% in 1990 and by 10% in 2000. Someone who started investing at the beginning of either of those years would have been down at the end of their first year.
Nonetheless, over time, even an investor who started in a down year for the index would have done well. To date, the FTSE 100 has never returned below 6% per year on average for a 25 year period.
That’s why it’s important to have a long time horizon when it comes to shares. With the stock market, investing for longer gives a better chance of impressive returns.
Investing risks
For someone looking to use their cash in the next few years, the stock market will be risky. For instance, that Cash ISA 3% return will be guaranteed, but the 6% expected from a Stocks and Shares ISA could fall short, not just in the short term but the long term too. Yetcan historically, owning a diversified stock portfolio has been a consistent way of building wealth.
I look to buy individual shares in my Stocks and Shares ISA with the aim of earning an even greater return. Whether or not I manage this, being investing in the stock market puts me on the right track.
