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Investing regularly in a Stocks and Shares ISA is one way to try and build a nest egg for retirement. That could end up being a sizeable amount of money.
For example, if someone wanted to try and build a £2m+ ISA by the time they retire, here are three things I think they ought consider.
1. Getting the right timeframe
With an annual ISA contribution allowance of £20,000 for most adults, time matters. In short, the more of it the better.
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Clearly, it is unrealistic to invest £20,000 a year before retiring and hope the ISA will magically balloon to £2m within 12 months.
What about a decade? That would involve total contributions of £200k, so hitting a £2m target would require an exceptionally strong portfolio performance.
But taking a 25-year timeframe would be more realistic, I think. Someone in their early forties with an empty Stocks and Shares ISA could put in £500,000 before they reach the retirement age.
2. Targeting a strong return
Another important factor is how well the portfolio performs.
Sticking with the example of investing £20,000 per year for 25 years, if the investor achieves a compound annual growth rate of 5%, at the end of the period, the Stocks and Shares ISA should be worth around £954,000.
At a 10% compound annual growth rate, though, that figure shoots up to over £1.9m, with the same annual contribution of £20,000.
Tantalisingly close to the £2m target! Moving that up to a 10.5% compound annual growth rate and the valuation of the Stocks and Shares ISA after 25 years should be £2.1m. Success!
That compound annual growth rate can be a mixture of dividends and share price gains, so I think a 10.5% target is achievable.
That said, share price declines could eat into the return. So too could fees and commissions, so choosing the right Stocks and Shares ISA seems like a smart move.
3. Risks matter, not just rewards!
It can be easy when dreaming of a seven-figure target to focus on shares that do brilliantly.
But it is always important to consider seriously the risks a business faces, not just potential rewards.
As billionaire investor Warren Buffett puts it, rule number one is ‘never lose money’ and rule number two is ‘never forget rule number one’. Easier said than done, but a useful reminder!
Over the past five years, for example, Lloyds Banking Group (LSE: LLOY) has seen its share price more than triple.
That blasts the 10.5% compound annual growth rate I mentioned above out of the water, before even considering the 4.1% dividend yield Lloyds offers.
Can the black horse bank keep doing well?
Potentially, it can. It has millions of customers and is the nation’s leading mortgage lender. It is massively profitable, with its statutory profit after tax topping £2.5bn in the first half.
Yet, I am not ready to buy Lloyds shares for my Stocks and Shares ISA in the current economic climate. It is not that I do not like the potential rewards owning the FTSE 100 bank could offer me. It is that the risk profile scares me.
In a weak economy, being the country’s largest mortgagee could mean big losses if many borrowers default. That puts me off buying the share in the current economy.
