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Retirement can seem a long way off – but it gets closer every day. Like many people, I use a Stocks and Shares ISA to try and build some tax-free wealth that hopefully will come in handy by the time I retire.
But how lucrative can such an approach be?
I will Illustrate that by explaining some of the key factors that determine the answer: the timeframe, the amount invested and the return.
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.
A long timeframe is an investor’s friend
The longer someone makes regular investments, the better it will hopefully be for the ultimate wealth generation potential of their Stocks and Shares ISA.
A longer period means more monthly (or weekly) contributions – and more time for investments to prove their worth, hopefully.
A 35-year-old today has around 32 years of working life left before the planned future state retirement age of 67. Financially savvy investors may be able to retire much earlier, but in this example we will stick to 32 years.
Investing now to benefit in retirement
The amount invested also matters. In this example I use a monthly contribution of £500.
That is £6,000 a year – well below most people’s annual Stocks and Shares ISA contribution limit.
Everyone’s financial situation is different. I think it is important to be realistic about how much one can afford to put into an ISA. That may not be the same amount each month for some people.
Finding shares to buy
The third variable is the compound annual growth rate (CAGR) of the portfolio value.
If that was 5%, at 67 the investor in this example would have an ISA valued at over £462,000. If the CAGR was 10%, today’s 35-year-old would be retiring with an ISA valued at over £1.2m.
In other words, the higher the CAGR, the bigger the long-term return will be.
The CAGR could come from dividends, share price growth or a combination of both. But it may be reduced by share price falls if shares are sold for less than they originally cost.
Another potential negative impact on the CAGR are the costs and fees of the ISA. Over decades those costs can eat up a lot of the value, so choosing the right Stocks and Shares ISA is important.
Setting realistic assumptions
A 10% CAGR may not sound very challenging, but in practice it is.
I do think it is possible, though, if someone is careful about stuffing their ISA only with high-quality companies bought at attractive share prices.
One share I think investors ought to consider at the moment is Greggs (LSE: GRG).
It already has a lot of momentum, having gained 27% since last month. But it still looks undervalued to me from a long-term perspective.
A trading update this week painted a positive picture of current and expected trading. With a large and growing network of shops, sizeable regular customer base, unique items and strong brand, I think Greggs’ proven business model can go from strength to strength.
Managing inflation and recent wage cost increases could hurt profits, though, while a sunny summer may dampen consumer enthusiasm for heavy pastries.
But on balance I see the share as a potentially very tasty bargain, so I recently bought some.