How Isa millionaires make it in five steps

By starting early with regular contributions and not shying away from risks, many more could reach a million

No one knows exactly how many Isa millionaires there are – Brewin Dolphin says it has just 15 such clients, investors with at least £1m shielded from the taxman in the Isa wrapper. But the stockbroker’s research suggests that achieving this elusive goal may be easier than some think. It has calculated that, if the stocks and shares Isa allowance rises at 2.5 per cent annually, and you make the maximum possible contribution each year, a 5 per cent annual return would see an Isa pot reach £1m in under 30 years. But discipline is crucial. Here are the five most important elements to becoming an Isa millionaire.

“It’s important to start saving as soon as you can,” says Tom Stevenson of Fidelity. Long-term capital growth is all about making the most of compounding. But this mathematical trick, where the returns on your investments themselves generate further returns, requires time. Both Fidelity and Brewin Dolphin’s models found that 29 years would be the minimum amount of time to reach £1m (assuming 5 per cent annual returns), meaning someone wishing to reach that goal in their 60s would have to start contributing the maximum in their early 30s. But there is always the possibility that the returns do not materialise, meaning an even longer time horizon may be required. You can’t really start too early.

Isas are run on a “use it or lose it” basis, meaning the tax benefits from a missed contribution in one year are lost forever. “Unlike pensions, you can’t use a previous years’ allowances retrospectively,” says Stevenson. Aspiring Isa millionaires should therefore aim to make the maximum contribution (currently £11,520 for the stocks and shares Isa, rising to £11,880 in 2014-15). This allows investors to make the most of the considerable tax advantages, including income and capital gains tax exemption from investments held in the wrapper (although the automatic 10 per cent income tax deducted from share dividends remains). Brewin Dolphin calculates that, over 29 years, capital gains exemption alone would total £292,215 under its model.

The assumption of 5 per cent annual returns is conservative, according to Guy Foster, the broker’s head of portfolio strategy. But even this would be unattainable in a cash Isa, which typically returns around 2 per cent at the moment. And the annual contribution allowance is also lower – currently £5,760 for a cash Isa. Stevenson points out that, over long time horizons, the number of years in which equities outperform cash is very close to 100 per cent.

Risk is an unavoidable part of investing, and taking on more of it is the only way to access higher returns. But according to Rebecca O’Keeffe of Interactive Investor, “long-term investors typically take less risk than they should.” Many existing Isa millionaires have done well from a few large bets on individual stocks, but this may not be the most sensible strategy to pursue in the early stages, says Stevenson. “Funds are a way automatically diversifying between individual stocks,” and many offer the prospect of enormous returns. The Legg Mason Japan Equity fund, for example, gained 62 per cent in 2013.

But as their capital grows, investors with the time to research riskier individual stock opportunities may want to consider staking a maximum of 15 per cent of their portfolio on such stocks, says Stevenson.

Selecting the right broker is also extremely important, says O’Keefe, and the devil can often be found in the detail. Those pursuing the often lucrative strategy of reinvesting dividends could see returns dampened by the fees charged for doing so by some brokers. Hargreaves Lansdown, for example, charges 1 per cent for automatic dividend reinvestments (with a minimum £10 and maximum £50 charge). And O’Keefe says that certain brokers also automatically reinvest dividends in the investor’s largest holding. “You wouldn’t want your income from a high-yielding stock like Vodafone to be reinvested elsewhere,” she says. “It’s extremely important to make sure the fee structure suits your investment needs.”