The simple maths that can make you an ISA millionaire

Compound interest means that hitting a £1 million ISA is not as impossible as it may seem. 

Everyone wants to be an ISA millionaire, but getting there will feel like a distant dream for most. This is particularly the case for those just starting out on their investment journey.

However, the simple but powerful maths of compound interest – where investment gains are reinvested – means hitting the magic £1 million may not be as difficult as you think.

The road to becoming an ISA millionaire can be mapped out when you make assumptions about investment returns, starting pot sizes, and monthly contributions. Inflation is also a factor to consider, as £1 million pounds in today’s money could be worth far less in 30 years’ time.

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Assuming a £10,000 starting pot with monthly investments of £100, and 6% annual investment returns (which is roughly what the UK market has historically returned a year, including dividends), it would take 61 years to hit one million. This is according to data from Candid Money, a financial education tool, and does not include the impact of fund fees.

However, 61 years is a long time to hit the seven-figure mark. Even if you started early – at age 21 – you would not achieve the feat until 82.

Doubling monthly payments to £200 a month cuts down the time to 52 years. Tripling contributions to £300 a month reduces it to 47 years.

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Adjusting monthly contributions is one way to speed up the journey, but increasing annual returns is even more powerful.

Assuming 8% returns, a £10,000 starting pot and £100 monthly contributions, it would take 48 years to reach the magic number.

With the same assumptions, 10% returns would need 40 years, while 15.5% annual returns, which is what Terry Smith’s Fundsmith Equity has delivered since launch in 2010, would require 28 years to get you there.

Starting with a larger pot also means a quicker path to £1 million. An investor with £100,000, compounding at 6% a year with no monthly contributions would need 40 years, while an 8% return would require 30 years and a 10% return would require 25 years.

A £500,000 pot would reach £1 million in just 12 years at a 6% annual return, 10 years at 8%, and eight years at 10%. If the investments are held inside an ISA then there is no tax liable on capital gains and income.

As Alice Guy, personal finance editor at interactive investor, says it is important to remember that achieving 15.5% returns won’t be realistic for most investors.

Guy adds: “We’ve just come through a period with historically high levels of returns and there’s no guarantee we’ll see that replicated in the future.”

Keeping your savings inside an ISA is extremely important for saving on tax.

As Guy points out, the benefits of ISA investing are even more important once you reach significant levels of wealth.

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She adds: “If you invest outside an ISA, you’ll need to pay dividend tax each year and capital gains tax when you sell your shares. If you own £500,000 worth of stocks with a 4% dividend yield, you’ll receive an amazing £20,000 dividend income each year. You could be facing a dividend tax bill of £6,075 per year, rising further once the dividend tax allowance reduces in April (assuming you pay higher-rate tax).

“Likewise, selling shares held outside an ISA could trigger a big capital gains tax bill. Selling shares worth £50,000 that you bought for £10,000 could currently trigger a tax bill of £5,540, rising to £6,800 in April, when the CGT annual allowance reduces.”

The ISA was introduced in 1999 when it replaced the share-focused Personal Equity Plan (Pep), which had been around since 1987, and the cash-focused Tax Exempt Special Savings Account (Tessa). It started life as a £7,000 allowance for stocks and shares, of which up to £3,000 could be used for cash; it rose above £10,000 in 2010, and in April 2017, the new ISA allowance went up to £20,000 per year and has stood at that figure since.

Source: Candid Money / interactive investor

What about inflation?

Inflation eats into the real value of money, so £1 million in today’s money will not buy the same amount of goods and services in 30 years’ time.

The Bank of England targets a 2% inflation rate and has historically achieved that, apart from periods of inflationary spikes, such as the present one and that of the 1970s. This means that a 2% return should be knocked off any calculations to give a better indication of the real value of £1 million.

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The extra number of years to reach the inflation-adjusted goal is shown above in the table. However, if inflation is above the 2% Bank of England target, then it will take even longer.

Guy says: “If inflation remains high, this will have a significant impact on the spending power of our wealth, and we may need to invest more to achieve a comfortable retirement.”