While saving money is a good idea, relying on a cash ISA to generate high returns in the long run may not be. At present, it’s difficult to find a cash ISA that offers an annual interest rate of more than 1.5%. And with interest rate rises set to be slow and steady over the medium term, it may prove very difficult to make a million from holding cash.
In contrast, buying shares in a range of companies could lead to significantly higher returns over the long run. While riskier, it could mean an individual is able to generate £1m in half the time that it would take to do so in a cash ISA.
Differing returns
To put the returns available from a cash ISA in perspective, an individual who contributes the maximum £20,000 allowed per year would take 39 years to have £1m. For most people, having £20,000 of spare cash every year for 39 years is highly unlikely, and shows just how challenging it is to generate a significant nest egg for retirement by relying on a cash ISA.
In contrast, an individual who instead invests the maximum £20,000 allowed per tax year in a Stocks and Shares ISA could generate £1m in half the time. That’s because it may be possible to gain a high single-digit percentage return over the long run, with the FTSE 250 having returned 9% per annum over the last 20 years. If it repeats this feat over the next two decades, in that time an individual could generate a £1m portfolio.
Risks
Clearly, investing in shares offers high potential returns. However, for many people its additional risks mean that they are cautious when it comes to buying stocks. This is understandable, since losses from investing in the stock market can be painful.
Risks, of course, can be mitigated through buying a range of shares. For new investors, a tracker fund may be a good place to start. This spreads the risk of investing across a wide range of companies, which means that the risk of poor performance from one or even a handful of companies is unlikely to prove catastrophic.
Of course, the stock market naturally ebbs and flows. But over the long term, it has always posted new record highs following a challenging period. Therefore, for an individual who has a long-term timeframe, investing in stocks could prove to be a sound move.
Modest investment
While the previous example discusses an individual who invests £20,000 per year in shares, that’s an unrealistic goal for the vast majority of people. Investing even modest sums on a regular basis, though, can allow an individual to benefit from the high potential returns offered by shares, and may create a sizeable nest egg for retirement in the long term.