The Stocks and Shares ISA is an excellent vehicle for generating passive income. That’s because dividends earned within the ISA wrapper are tax-free.
That’s great for all of us, but just imagine if you were one of the UK’s 2,000 ISA millionaires. The top 60 holders have portfolios with an average value of £6.2m.
Theoretically, if that average millionaires’ portfolio was invested entirely in Legal & General right now, the holder would earn £496,000 in tax-free income this year.
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It seems like the stuff of dreams. But, in theory, it’s entirely possible for an investor like to me achieve this too. So let’s have a look at how this could be done.
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.
Time is key
Let’s imagine I’m starting with £10,000. Well first, if I invested that all in Legal & General — one of the top-yielding FTSE 100 stocks — today, I’d only receive just over £800 a year. That’s clearly not going to change my life.
As we’ve seen, to earn £496,000, I’d need to turn my £10,000 into £6.2m and then invest in stocks with 8% dividends. So how do I build a pot that big? Well, it’s going to take time, and regular investing.
A compound returns strategy is the safest way to develop a portfolio — that’s my opinion. But it’s certainly less risky than investing in promising growth stocks that may come to nothing. As billionaire investor Warren Buffett says, the first rule is don’t lose money!
With my portfolio, I aim for low double digit growth year on year. And this is something I’ve broadly been able to achieve, despite the recent volatility. But with £10,000 growing at 11% annually, it would take me 59 years to reach £6.2m.
So it’s possible, even with limited starting capital. But 59 years is a long time, and £6.2m might be worth much less by then.
Using less time
‘Time is precious’, to poorly paraphrase philosopher Seneca. Let’s face it, we might not want to wait 59 years to start drawing down on our portfolio. So how can we expedite the process?
Well, the next step step would be to contribute regularly. By adding £400 a month, and then increasing that contribution by 5% annually, I could reduce the time needed to reach £6.2m. Instead, it would take 40 years.
Obviously, we’re still talking about a long period of time. But if I had started this when I finished my undergrad at 22, and continued until 62, I could have developed a portfolio that would allow me to retire early.
Of course, this isn’t a guaranteed strategy, and I could lose money. But it’s certainly a less risky way of creating a giant ISA portfolio worth £6.2m. And by investing consistently over a long period of time, I can hope to iron out the peaks and troughs of the market.
