Top tactics on how ISA millionaires invest

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With just days until this tax year ends and a new one begins, the focus for this week’s episode is on the increasing number of ISA millionaires and how you can join them. To discuss how ISA millionaires invest, the steps taken to achieve the milestone, and what to consider when weighing up ISAs and SIPPs, Kyle is joined by Craig Rickman, personal finance editor at interactive investor.

In this episode, Kyle mentions a recent article: Best-performing funds and sectors since ISA launch in April 1999

• Learn with ii: How to become an ISA millionaire | ISA Investment Ideas | Top ISA Funds

Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to our latest On The Money episode, which is a weekly look on how to make the most out of your savings and investments.

Joining me today is Craig Rickman, interactive investor’s personal finance editor. Craig, welcome back to the podcast.

Craig Rickman, interactive investor’s personal finance editor: Thank you very much for having me back, Kyle.

Kyle Caldwell: So, Craig, we’re going to focus this episode on ISA millionaires, including how realistic it is to become one, how many ISA millionaires we have at interactive investor, and then we’re going to look at the types of investments that are the most popular with ISA millionaires.

To kick off, we’ll look at how easy is it to become one. Before the podcast, we chatted and came up with an agenda. Craig, I think you’ve looked at some statistics to show that if you filled the ISA allowance every single year since the 6 April 1999 to today, then you’d have quite a sizeable pot without any investment growth.

Craig Rickman: Yes. That seems like a really good place to start. So, for those watching on YouTube, we will share a graphic on the screen.

So, if you’ve maxed out your ISA allowance every year from when the product was launched in April 1999, you could have paid in a total of £346,560. So, that’s up until the current tax year, ends on 5 April.

We should note though that before ISAs, we had personal equity plans (PEPs), which were introduced in 1987 and ran up until ISAs. So, ISAs effectively replaced them and PEPs, as they were known, all PEPs became ISAs at some point. That happened by 2008.

So, effectively, you could invest in sort of an ISA wrapper since the late 1980s. So, coming up to 40 years. And if you add in the total possible PEP contributions, the total rises to £434,760. So, a significant sum.

Kyle Caldwell: In terms of how realistic it is to become an ISA millionaire, the first thing I’d say is don’t become too sort of hung up on it. If you can invest as much as you can in a given tax year and you have a decent amount of investment growth over time, then compounding will work its magic. That’s when investment returns themselves generate future gains. So, even more modest sums can turn into a very significant sum over time. 

However, I did do some number crunching. If you started with £10,000 and then you invested a monthly sum of £100 and had an annual return of 6%, which is not unreasonable. That is broadly what the UK stock market has given you in its history, then it would take 60 years to reach that £1 million target.

Now, if you’re 21, even if you start young, that means that you’d be 81 by the time you become an ISA millionaire. So, if you do become an ISA millionaire - and we do have a small but not insignificant number of customers who are ISA millionaires - I think it’s a really impressive achievement.

We’ll come on to it a bit more later on, but I do think to get there, you’d have to have maximised the allowance in most years, if not all, and also had some very impressive investment growth as well.

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Craig Rickman: Yeah. I think you’ve summed up perfectly there. It’s not out of reach for people, but it really is a very impressive and lofty achievement, primarily because, or one of the reasons, is you are restricted on what you can pay into ISAs every year. It’s £20,000 at the moment. That’s the ISA limit. But going back over the years, it’s been a lot smaller.

So, when ISAs were first launched, the most you could put in was £7,000. That probably would have felt a bigger sum at the time for people due to inflation. But still, you would have had to, in order to become an ISA millionaire, for those who are ISA millionaires now, use your allowance every year and, like you say, benefiting from the superpower that is compounding returns, that’s the best way to help you get there.

Kyle Caldwell: Going back to the example that I’ve just given. If you upped your contributions and you had that same level of investment growth, you get there earlier.

For example, if you doubled those monthly payments to £200 and you invested an initial lump sum of £10,000 and you had that 6% annual return, then that would cut it down from 60 years to 52 years.

If you tripled your contributions to £300 a month, that would reduce that further to 46 years.

However, while adjusting the monthly [payments] does reduce the length of time it takes to become an ISA millionaire, I think the most important part of the equation is the annual returns.

Assuming you had annual returns of 8% rather than 6%, using the same example, if you had a £10,000 lump sum and £100 a month going in, then it would take 47 years as opposed to 60 years to reach that magic number.

I think 10% returns a year is not realistic, but if you did achieve that, it would take you 39 years.

So, it’s a mixture. The key ingredients are the amount you put in, but also a very important part of the equation is what the actual investment returns have been. Those small differences in terms of the percentage returns can make a huge difference over time, and that’s also down to compounding.

Craig Rickman: Yeah. Another aspect as well is resisting the urge to dip into your pot over time.

Now, there could be very good reasons why you might want to access your stocks & shares ISA, and the fact that they are flexible and accessible is one of the key advantages of them.

But obviously be aware that any money you take out is going to extend the time period that it would take you to become an ISA millionaire.

Kyle Caldwell: In terms of the number of ISA millionaires we have as customers at interactive investor, we’ve seen a 79% increase over the past year. So, we have 2,869 ISA millionaires, and that’s up from 1,607 a year ago. Those figures are based from the end of February last year to the end of February this year.

Craig, what would you say is the main reason why we’ve seen this big increase over the past year?

Craig Rickman: The first thing to say there is that’s a huge increase over a 12-month period. But, as you say, a few reasons could be driving that.

One of the key ones has been portfolio performance. Most people would have enjoyed some big gains over that period due to increases in stock markets. That would be one.

Another factor is that people have had more time to pay into an ISA, so they’ve had an extra year’s allowance. So, over time, because ISAs launched in 1999, with every passing year, people could have paid more money into the tax wrapper, that gives them a better chance of reaching that holy grail of ISA millionaire status.

Another factor could be that at interactive investor because we charge a flat fee, they tend to be more beneficial for bigger portfolios because it doesn’t really matter how much you have in your ISA, you’ll still pay the same account fee. So, that could have prompted people to shift their ISAs to interactive investor from elsewhere.

Kyle Caldwell: Yeah. I completely agree. I think the strong performance of the UK stock market last year has tipped people into the millionaire status for ISAs.

If you had around £900,000 a year ago, the FTSE delivered over 20% last year. So, if you just had a FTSE tracker fund, obviously, you’re not going to have a FTSE tracker fund for the whole of your portfolio, but if that’s contributed and your overall portfolio has had a really strong year and it’s done more than 10%, then you’d either be very close or you would get over if you had £900,000. You’d need about a 12% or 13% return to tip you over.

Craig Rickman: Yeah. That’s a really good point, isn’t it. It’s not been a result of people taking particularly aggressive risks over the past year. It’s just that they’ve been invested in the markets and particularly, as you say, had exposure to the UK.

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Kyle Caldwell: We’re going to move on in a moment to look at the best-performing funds since ISAs were launched, and we’ll also take a look at the top holdings among our cohort of ISA millionaires.

But before we move on to both of those, I just want to quickly cover off the key differences between an ISA and a self-invested personal pension, a SIPP.

Of course, you can have both, but depending on where you are in your investment journey, you could favour one over the other at certain points in your journey.

Craig Rickman: This is a really interesting topic to briefly delve into because while becoming an ISA millionaire is an incredible achievement, perhaps something that would be a bit more palatable for people as a first milestone would be to become a portfolio millionaire.

So, that includes pensions and ISAs in the mix, because in some cases, it might be better for your money if you’ve got any spare cash left over to put that into a pension, such as a self-invested personal pension or a SIPP instead of an ISA.

So, some of the key differences: there are two ways that they differ really. They’re both tax wrappers and both are really good ways to save for your long-term future. The two differences centre around how the tax advantages work and access and flexibility.

With a pension, you get upfront tax relief, which is at your marginal rate of tax, so the rate of tax you pay on the next pound you earn. So, you get that money on the way in.

When you take money out, when that time comes, you can take up to 25% of the fund tax free, or most pensions allow you to, and the rest is taxable.

So, pensions benefit those where the tax relief that you get on the way in is higher than the tax you pay on the way out. So, if you’re a 40% taxpayer, when you’re paying money into a pension and you pay 20% on the way out, that’s where they work really, really well from a tax perspective.

With ISAs, you don’t get any tax on the way in, but withdrawals are tax free. So, it reverses.

The big difference is around access. With an ISA, you can access the money whenever you like. With a pension, under current rules, you’re restricted to age 55, but that’s rising to 57 in 2028.

So, understanding how the two work is really important because depending on what your goal is, one will be more suitable than the other.

But for most people, if you’ve got a really well-rounded portfolio, then you’ll have some money in a pension, such as a SIPP, and some money in an ISA as well.

Kyle Caldwell: If you become an ISA or a SIPP millionaire, both are remarkable feats. But I’d argue that becoming an ISA millionaire is a greater achievement because you’re not getting the tax relief on the investment return. Your money’s not getting the tax relief boost.

Also, with an ISA, there’s more opportunity to dip into it and potentially pull money out. Whereas obviously with a self-invested personal pension, you can’t dip into it until you reach a certain age.

Craig Rickman: Absolutely. And the annual allowances, the limits that you can pay into each tax wrapper are different. So, they’re more generous for a pension. So, you can pay up to a 100% of what you earn, capped at £60,000. You might be able pay more using something called carry forward relief.

But with an ISA, it’s £20,000. So, whichever way you look at it, the options to pump money into pensions every year, or the scope, is a lot higher than ISAs as well.

So, yeah, hence why, like you say, becoming an ISA millionaire is probably a harder thing to do.

Kyle Caldwell: Let’s now move on to the best-performing investments since ISAs were launched on the 6 April 1999. We recently published an article on this on the interactive investor website, which is ii.co.uk.

What we found was the more adventurous types of funds and investment trusts performed best over that long time period. We looked at the best-performing overall funds and the best overall sectors.

So firstly, sectors. Of the top 10 sectors, nine of the 10 are investment trusts. For me, the key reason why that’s been the case is because investment trusts have the ability to gear. They have the ability to borrow to invest.

Over a very long time period, this should work in their favour over an open-ended fund. Because over a very long time period, you’d expect the market to go up, and gearing will magnify those gains.

And very briefly, in terms of the individual winners, since ISAs were launched on the 6 April 1999, the top five were Aberdeen Asia Focus PLC (LSE:AAS), Scottish Oriental Smaller Cos Ord (LSE:SST), Pacific Horizon Ord (LSE:PHI), BlackRock World Mining Trust Ord (LSE:BRWM), and HgCapital Trust Ord (LSE:HGT).

Craig Rickman: Yeah. Interesting, isn’t it. It really does illustrate the importance of building an ISA portfolio that’s diversified.

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Kyle Caldwell: I completely agree. We speak about diversification a lot on this podcast, and we do because we think it is very important and it’s worth repeating numerous times. If you have a portfolio that’s heavily exposed to one area or one particular share, fund or investment trust, then you’re exposing yourself to pretty high levels of risk over time. And it might go well for a period, but things can also turn badly as well.

Craig Rickman: They can, yeah. There was an article recently that showed some people were eight-figure ISA millionaires. Like the super-ISA millionaires…with an average of £11 million in ISAs.

Needless to say, to have accrued those size pots would have required a pretty aggressive investing strategy. You wouldn’t have been able to get there purely by investing in the stock market.

What may be overlooked in that respect are the risks that you have to take on to do that, and it could have gone the other way for those people. I mean, ultimately, the investments that they backed, the shares that they backed, were wildly successful. But, yeah, there was no guarantee that that was going to happen.

Kyle Caldwell: I mean, while that’s worked out for those super ISA millionaires, I’d be a lot more comfortable spreading risk a lot further and wider than that.

One trend that we see among our ISA millionaires at interactive investor is that they are very active. They do trades quite frequently. On average, they make 30 active trades in a given year.

So, it’s hard. I wouldn’t want to completely generalise, but for me, they’re not just buying and holding and coming back to the portfolio in a year’s time. They’re reviewing the portfolio a lot and making changes accordingly and potentially cutting losers, taking profits, and then reinvesting into undervalued areas that they’re hoping over time will recover their poise.

When looking at the top 10 holdings for the cohort of ISA millionaires, we don’t see any racy stocks in the top 10 or smaller companies. We see UK large blue-chip companies. So, seven of the top 10 are FTSE 100 stocks, and they are Rolls-Royce Holdings (LSE:RR.), Shell (LSE:SHEL), AstraZeneca (LSE:AZN), National Grid (LSE:NG.), GSK (LSE:GSK), Rio Tinto Ordinary Shares (LSE:RIO), and Lloyds Banking Group (LSE:LLOY).

The other three in the top 10 are Alliance Witan Ord (LSE:ALW), Scottish Mortgage Ord (LSE:SMT), and City of London Ord (LSE:CTY), which are all investment trusts. Compared to our non-ISA millionaires, one of the key differences between the top 10s is that there’s a greater preference for owning individual stocks.

That might be down to greater levels of experience, and therefore, in some instances, greater confidence in owning individual stocks. Also, many of the blue-chips are dividend-paying companies. So, the average age of our ISA millionaires I think is 72.

At that stage, you’re looking for your investments to throw off a decent level of income. Well, some people are. That’s a strategy that a lot of people adopt because it can help fund your lifestyle in retirement.

Craig Rickman: Yeah. I think that’s the two elements. They’ve got more skin in the investing game. They’ve got more experience. They feel more comfortable taking on or investing in single-company stocks.

But also, yeah, they’re at a point in life where they want to enjoy the income from their ISAs and the tax-free income. I guess that’s one of the really key aspects that they’ve built these really impressive seven-figure portfolios, and now they want to enjoy the fruits of their labour.

Kyle Caldwell: To me, it’s also interesting that there’s no global tracker funds, no global index funds or exchange-traded funds (ETFs) in the top 10. Again, I think that might be down to the average age of the ISA millionaire and where they are on their investing journey. They’re looking more for income-producing investments over growth investments.

I think index funds and ETFs are more in the accumulation stage, when you’re building up your pension pot, they’re great options to have as a potential core holding. But when you come to retirement, you might be a bit concerned about the potential volatility of owning the whole market at that point.

Craig Rickman: Yeah. Absolutely. I think it’s worth remembering that these lists reflect what people are owning today, not necessarily the stocks and the investments that they’ve chosen on the route to becoming an ISA millionaire. So, once they’ve got there, it’s highly possible that they might have changed strategies.

Kyle Caldwell: Yeah. I completely agree. I think that’s very important to bear in mind that the top 10 holdings for ISA millionaires, that’s what they own today rather than what they owned in the past.

In terms of investment types, an interesting trend is that we see ISA millionaires having a greater preference for investment trusts. The average ISA millionaire holds just under a third in investment trusts. For non-ISA millionaires, the figure is just below 15%. That’s quite a big difference.

I think that reflects that a number of investors are very savvy and very aware of the structural advantages that investment trusts have over funds. Over the long term, gearing can magnify returns. And those statistics I ran through earlier about the long-term returns for various sectors and funds investment trusts really do show that.

Of course, it can go the other way in a falling market. Gearing can magnify losses, but I do think if you’re holding for a very long time period of 10, 20, 25 years, over time, the ability to gear if the investment trust does choose to do so, can really work in the favour of private investors.

In terms of other trends, the typical ISA millionaire is more likely to get their business done early at the start of the new tax year.

For me, one of the main benefits of doing that is that you’ve got an extra year in the market. Another potential benefit is that if you leave it a bit too late and you’re investing towards the end of the tax year, you might be a bit too hasty and you might buy something that you then end up regretting.

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Craig Rickman: I think one thing that we should also acknowledge around that is that it’s contingent on having sufficient capital at the start of the tax year. So, some people have deployed any spare cash in the previous tax year to top up their ISAs or potentially their pensions as well. But if you do have spare cash, get it in early, enjoy an extra year in the market, potentially an extra year of dividends. That’s something that ISA millionaires do. And, yeah, there are clearly some benefits to doing that.

Kyle Caldwell: The final point is inflation, which I should have mentioned earlier. So, when I ran through those calculations regarding how long it would potentially take to become an ISA millionaire, they didn’t factor in inflation. The reality is, if you’re starting today and you want to try and become an ISA millionaire, £1 million in today’s money will not be the same as it is in the future due to the effect of inflation.

Craig Rickman: Yeah. It’s really important to factor inflation into your future financial goals. For most people, the goal isn’t necessary to become an ISA millionaire. It’s to accrue enough money that you can have financial security and financial freedom down the line. But, as you say, inflation over time can chip into the buying power of your money. So, it’s really important to factor that in when setting yourself future financial goals.

Kyle Caldwell: Finally, in terms of a few quick pointers, many of which we’ve already discussed on the podcast in terms of the sort of ingredients you need when trying to become an ISA millionaire or to build a significant pot to give yourself financial freedom later in life.

For me, it’s invest what you can afford to invest. Be mindful of having a diversified portfolio. Don’t put all your eggs in one basket. Be patient and think long term. Any others to add to that list, Craig?

Craig Rickman: Absolutely. I agree with all of those. A couple of final points is don’t overlook pensions when you’re looking to accrue wealth for the future. You get the upfront tax relief, like we’ve mentioned, and it can give your money an immediate boost. And, if you pay higher rates of tax, you can claim some extra back.

But also if you are employed, then you’ll be part of a workplace pension as well where your employer has to contribute into a pension but up to certain levels provided you do. So, making the most of the facilities of pensions, upfront tax relief and employee contributions, can give your wealth a boost for the future.

Kyle Caldwell: Craig, thanks for your time today.

Craig Rickman: Thanks for having me.

Kyle Caldwell: Thank you for listening to this episode of On The Money. We hope you’ve enjoyed it. We love to hear from listeners, and you can get in touch by emailing us at: OTM@ii.co.uk. In the meantime, you can find plenty of practical pointers and analysis related to funds, investment trusts, ETFs, and personal finance on the interactive investor website. I’ll hopefully see you again next week.