Celebrating ISAs and SIPPs in the current financial climate is like celebrating electricity in the 21st century. Gratitude is a good quality to have but there has to be a limit! Tax is necessary but I’m dubious about income from post-tax savings being taxed as well. It’s like a never-ending tax Inception. Anyway it is what it is and that’s why at UKdoctoronFIRE, we always advocate tax efficient investing within.
I presume the government agrees with me to some extent which is why in a few months time, the annual ISA allowance will rise to £20,000. This will challenge the best savers amongst us to the next level.
Have you ever considered how long it’ll take you to double your money? Depends what it is I guess – on the roulette table it’s approximately 10 seconds but some people may never double their money even in a lifetime.
Enter the rule of 72.
Years required to double your money = 72 divided by your annual investment return
For example, if you deposited £20,000 into a cash ISA earning 1% annual interest then it’ll take approximately 72 years to double your money. Maybe you’re a patient person? But we need to consider the real purchasing power of £40,000 in 70 years time, which will be a lot less than £20,000 in today’s money.
Double your interest rate to 2% halves your doubling time to 36 years.
And if you can achieve the UK historical average of 7% with equities then your £20,000 will grow to £40,000 in a respectable 10 years. With a high enough annual investment return you can potentially double your money several times over a lifetime.
Come April 2017 let’s say you invest £20k into a UK All Share tracker within an ISA. For simplicity let’s also say your annual return for the next 10 years is an annualised 7.2%, comprising 3.6% fund capital growth and 3.6% dividend payment each year. As we’ve established above, you’ll have £40,000 by April 2027.
However a quick calculation reveals that annual capital growth of 3.6% only grows your fund to £28,000 in ten year’s time. Where does the additional £12,000 come from? Dividend growth of an identical 3.6% surely only grows this by another £8,000 to £36,000 right?
The answer comes in the form of dividend reinvestment and compound interest working in your favour, boosting your total by a further £4,000. Combine ISAs, dividend reinvestment and the rule of 72 and you’ll reap the benefits of doubling your money within a tax efficient wrapper several times in a lifetime.
P.S. I learned everything I know about finance from this book, this book and that one, amongst many others. For a more extensive list, don’t hesitate to drop me a line at email@example.com. If you prefer learning through listening use this link to earn a free audiobook of your choice by signing up to their 30-day free trial. Simply cancel with the click of a button if you decide later on that the service isn’t for you, no questions asked.