If I could only give one piece of advice to someone who wanted to build wealth with a Stocks and Shares ISA, I’d use this quote from Albert Einstein: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
The idea is the power of compound interest is so strong that it’s almost a secret. Take advantage of it and I can earn big. And if I crunch the numbers, I can see how it turns even a modest sum into millions of pounds.
Let me run through an example to show what I mean. I’ll use a £1,000 per month saving and I’ll give it a 10% per year interest – not a crazy amount to expect from the stock market. Here’s what happens.
| £1,000 a month | |||
| 0% | 5% | 10% | |
| 1 year | £12,000 | £12,323 | £12,641 |
| 5 years | £60,000 | £68,090 | £77,172 |
| 10 years | £120,000 | £154,992 | £201,458 |
| 20 years | £240,000 | £407,458 | £723,988 |
| 30 years | £360,000 | £818,698 | £2,079,293 |
Over two million quid! That seems hard to believe when I save only £12,000 a year, but it’s just compound interest doing its stuff. As I reinvest the returns, the interest builds and builds like a snowball that gets bigger as it rolls.
To be specific, I only get £641 interest in the first year. That sound like nothing. After all, how will a few hundred quid turn into a few million? The trick is that the compounding hasn’t got going yet. It doesn’t do much at first.
Ramping up
Even in the second year, I only get back £1,904. That still seems low and a long way off the multimillion figure I’m aiming for, but it’s nearly three times what I got in the first year. I can see it’s starting to ramp up.
By the 30th year though, my interest has shot up all the way to £188,518. Nothing has changed, by the way. It’s still the same deposit. But now the return has grown into an income that might make a City banker blush.
Another way to look at it is that I’ve put in £360,000 but the interest has added around £1,800,000. Most of the money I’d have is from that interest. Without it, a ‘retire early’ figure like £2m is little more than a pipe dream.
It’s true that £1,000 each month might be hard to achieve for some, but even if I dial down the savings, compound interest still rips. A £200 a month saving would turn into £415,859. Still pretty nice and over double the average British pension pot. Not too bad if I can get there.
How to achieve it?
So how do I get this for myself? Well, I need a percentage return for the compounding to work, and investing in companies offers me perhaps the highest I could get. A Stocks and Shares ISA is a great place to start too,as I can avoid paying dividend and capital gains tax on smaller deposits.
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.
Stocks can be risky, to be fair. I did the maths above with a steady return each year, but stocks go up and down like a rollercoaster.
Equally, nothing is guaranteed with this kind of investing, A 10% return seems doable if I look at past returns from the stock market, but what about the future? Anything could happen. Who knows, a climate crisis might stop humans from making the kind of money from stocks that they did in the past. Yet I feel confident that investing in stocks and reinvesting my returns could unlock great wealth for me.
The post 1 multimillion pound reason to open a Stocks and Shares ISA appeared first on The Motley Fool UK.
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John Fieldsend has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
