The concept of the Isa Millionaire emerges like clockwork at this time of year. While many savers are wondering whether or not to even bother opening a Cash Isa with rates so low, industry bods are doing complicated sums to show how investing £20,000 a year could make you rich.
While the annual Isa allowance is undoubtedly generous, it is the stuff of dreams for most savers. And yes investing £20,000 a year for 25 years with annual growth of 5% could make you a millionaire, but those figures are irrelevant for the majority of people.
So, can the average Joe or Josephine ever become an Isa millionaire?
Let’s take a quick look at some numbers: the average savings ratio (the percentage of savings as a proportion of household disposable income) of UK households rocketed in 2020 when lockdown was first upon us and few people were venturing out of doors. Figures from the Office for National Statistics show the ratio soared to 27.4% in Q2 2020, shown in the chart below.
Of course, this varies widely depending on age and income. Around 40% of those aged 22 to 29 years old have no savings at all. The average savings of those age 18 to 24 in the UK is £2,481, rising to £5,995 for those aged between 35 and 44, and £20,028 for the over 55s.
Still, if we go back to the average savings ratio chart above, we can see that over the long-term the ratio has hovered around 10% mark.
Let's Run the Numbers
The ONS reports that in 2020, the average UK household annual disposable income was £30,800. A savings ratio of 10% would mean £3,080 to set aside for project Isa Millionaire.
If you saved £3,080 a year into a savings account and it grew at a rate of 1% a year, after 25 years you’d have £114,421. For the purposes of this illustration, we’ve increased the amount saved by 2% (the inflation target) each year to reflect a growing wage, something which couldn’t be done in the original example as the saver had already hit the Isa limit.
If you invest the money rather than leave it a paltry-paying savings account, and it grows by 5% a year, after 25 years you have £193,411 – better, but still not in millionaire territory. In fact, with annual growth of 5% you’d have to save for 51 years to reach millionaire status. That’s doable if you start saving young, but the effects of inflation mean a million might not buy you much by that time.
If you could achieve annual growth of 20% you could meet the mark in 21 years – but not even the most seasoned of investors are likely to be able to produce such outperformance for more than two decades.
So what are some practical steps the typical saver can take towards becoming an Isa millionaire?
1. Start Early
The earlier you start saving, the longer your money has to grow, and the greater the effect of compounding. Those lucky enough to have parents or grandparents putting money into a Junior Isa for them are most likely to make the million.
If your family invest £3,080 a year (increasing by 2% a year) into a Jisa for you from birth and it grows at 6% a year, and you then continue to invest at the same rate upon taking over the account at age 18, you’ll be a millionaire by age 46.
2. Increase your Contributions
The above examples all rely on increasing the amount you save every year. Not by much, we’ve used 2% in our illustrations as that’s the Government’s inflation target. That means if you save £1,000 in year one, you save £1,020 the next year, and so on.
The trick when investing regularly over the long-term is to make sure you increase the amounts immediately whenever you get a pay rise. Do it straight away before you get a chance to get used to spending the extra cash! Not only does that mean you’ll save more over the long term – in the Jisa example you save £3,080 in the first year and £7,391 in the final year – but your savings keep up with inflation and living costs.
3. Stay Invested
We know it’s “time in the market, not timing the market” that works over the long-term. That means the next tool to help you become an Isa Millionaire is investing and staying invested, regardless of the ups and downs along the way.
Last year was a prime example of how this strategy can reap rewards. The US S&P 500 dropped around 30% in the height of the Covid-19 pandemic but had recovered within four months and ended the year up more than 15% at a record high.
Any investor who panicked and sold during the uncertainty locked in their loss and missed out on the recovery. Analysis by Morningstar’s Paul Kaplan analysed the US market over 150 years and a $1 investment would have grown to $22,580 if you’d have left it invested through all the market crashes over those years.
