The Stocks and Shares ISA allows me to put away £20,000 each year and not be taxed on any increase in its value. There are plenty of way to use your ISA. But for me, it’s a vehicle to develop wealth over the long term by reinvesting my profits and compounding income.
So, here’s what I’m doing to build wealth, and hopefully retire early.
Reinvesting profits
Some people are fortunate enough not to need their profits now. So, instead of taking my dividends or profits, I can reinvest them into my portfolio. This allows me to benefit from something known as compound returns or compound interest. This is the concept of earning interest on your interest.
For example, let’s say I were to invest £10,000 in HSBC, which currently has a fairly modest dividend of around 4%. Assuming the dividend and share price stayed flat, I could expect to have more than £22,000 if I were to reinvest my dividend over a 20-year period. Over a 30-year period, that figure rises to £33,000.
Starting young is key here as the longer the period I reinvest my returns, the greater the impact of compounding. The above calculation makes no allowance for changes in the share price, although I’d hope to see HSBC stock move upward over that period of time.
It’s also worth noting that if I can find a stock I’m confident in, with a higher yield, the growth could be much higher than in the calculation above. For example, reinvesting my dividend from a stock like Imperial Brands, which has a 7.5% yield, would be much more lucrative. £10,000 would become £44,000 over 20 years, and £94,000 over 30 years, assuming the dividend and share price remained flat. But personally I see too much risk in tobacco, especially in the long run.
Sensible picks
I could certainly grow the value of my ISA with well-chosen growth stocks, and I do have some exposure there. But profit-making, dividend-paying stocks are core to my strategy and allow me to compound my returns.
If I’m investing for 20 years, I want to invest in companies with strong long-term prospects. For example, policy changes could really hurt tobacco firms, so maybe Imperial Brands wouldn’t be a great choice. After all, 20 years is a long period of time. Some companies may have gone bust. So, I need to manage risks and make sensible choices.
While there may be increased competition from FinTechs, I see established lenders like Lloyds as a good pick. The bank is particularly exposed to the property market, which I see being strong in the long run, and margins could improve with higher interest rates. The last decade has seen historically low interest rates, which have negatively impacted Lloyds’ margins.
In a similar vein, I like housebuilders, like Vistry Group, which are currently offering big dividends. I don’t see demand for houses subsiding in the long run, although there may be some short-term pain.
Insurance is another area I’m keen on in the long run. Again, FinTechs may eat into the market share of established firms. But, car insurance for example, is a legal requirement and demand should remain constant.
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.