How to become an ISA millionaire
1) Be disciplined and patient
The first thing you will need is patience. You need to realise that you're not going to become an ISA millionaire over night. A basic rule of investing is not to be greedy. A classic mistake is to put all your money into one stock, fund or country. This exposes you to an unnecessary amount of risk and will usually end in tears.
2) Have a long time horizon
Following on from the first point, you will need a long investment time horizon. This will give your investment the chance to grow over time and allow for the magic of compound interest to take hold (interest on interest). It may also allow you the freedom to be more aggressive with your investments as you won't need to worry about having to withdraw your money in the near future.
3) Contribute as much as possible
The third thing you will need to do is contribute as much as possible and make use of your full ISA allowance. Obviously the more you contribute the faster you will reach your goal. This won't be possible for everyone, but as shown in the examples at the bottom it is still quite possible to become an ISA millionaire with smaller contributions. However, one thing you must ensure is that you pay off any high interest debts you have before you invest.
4) Invest in equities and avoid cash
Equities have consistently beaten all asset classes over the long term, although they are more volatile. Please note it is not appropriate to hold all your assets in equities if you wish to withdraw your funds in the near future. Investing 100% in equities should only be for someone who will never need to touch this investment in the short term and has the specific goal of becoming an ISA millionaire.
5) Do research
Do spend time researching the best fund managers. This can be done relatively simply at websites such as fundcalibre.com and is much easier than researching individual stocks. The annual rate of return you achieve on your investments will make an enormous difference to how quickly you achieve your goal. Neil Woodford, one of Britain’s best known investors, has achieved an annual return of 13.2% for over 26 years.* To put this into perspective, go back to our saving a pound a day example above. If you saved £1 a day for 77 years at 13.2% instead of 7%, you would end with a lump sum of £43.8m not just £1m.* (If you don't believe me, do it yourself; go to www.moneychimp.com/calculator/compound_interest_calculator.htm)
Billionaire investor Warren Buffet achieved a 19.7% annual rate of return between 1965 and 2012.** Now you can see why he's a billionaire!
6) Don't be greedy
Whilst it's true that good returns make a huge difference to your final lump sum, don't try and achieve the impossible. Woodford and Buffet’s performance numbers are exceptional and it is extremely unlikely you will be able to match them. Remember they achieved less than 20% a year, so forget any ideas of daily trading or doubling your money in a couple of weeks. Aim for a sensible achievable annual return of around 7%. Under no circumstances should you put all your portfolio in to one or two individual shares.
7) Don't over trade
This comes back to the first point about being patient. Predicting market movements is extremely difficult. Overtrading will be a waste of your energy and will only give money to your broker. Don't try and time the market; this could cause you to miss out on vital returns. Have a review of your portfolio every 6-12 months and cut funds which are performing differently from how you initially expected.
8) Don't panic
Prepare yourself for market stress now. Sadly you won't make a consistent 7% return every year. Some years you might make 20%, other years you might lose 10%. If you're investing in equities for a long period there will definitely be times the stock market declines 30%, 40% even 50% or more. Panicking out at the bottom of these declines is a classic investment mistake and will stop you reaching your goal. Prepare for this now so that when chaos is raging around you, you can calmly continue to implement your plan.
9) Invest globally
Diversify. You want to take advantage of growth from all around the world. Investing too heavily in one area could cause your investments to struggle if that one area does poorly. By investing globally you can be sure to take advantage when different parts of the world do well.
10) Re-invest all your dividends
Make sure you re-invest dividends. This is absolutely crucial and if you don't do this you will have little chance of achieving your goal. Re-investing dividends allows the magic of compound interest to take hold, whereby the dividends you've re-invested generate further dividends in the future (interest on interest).
Conclusion
If you invested the full £15,000 a year into your ISA, and achieved a 7% annual return, you would finish with over a £1,000,000 after 25 years.*** Start with nothing on your 20th birthday and you could be a millionaire by the age of 45 with this plan. Not bad, but this does assume you save £15,000 a year, which is by no means an easy task. However, if you invested £5,000 over 40 years at a 7% annual return, you would also end up with over £1mn.*** Becoming an ISA millionaire is something we could all achieve if we put our minds to it.
*Barclays Stockbrokers; Market Review: A record-breaking start for Neil Woodford's new fund; published 05/08/2014
**http://www.ft.com/cms/s/2/25870c9c-9d69-11e3-a599-00144feab7de.html#axzz3Qlcvkybg
*** www.moneychimp.com/calculator/compound_interest_calculator.htm