Who wants to be an ISA millionaire?

With the ISA deadline having just passed, I’ve been getting more than a few ISA-related questions coming into my inbox. So I thought I’d put together a couple of posts along that theme.

Next week’s post will be a collection of ISA FAQs, but this week I thought it might be interesting to see how difficult it is to become an ISA millionaire, given how much these savings gods seem to be plastered around the news this time of year.

All of us (myself included) tend to attribute some level of cosmic significance to round numbers, even though we all know there’s nothing special about the magic £1m mark. But then again, there aren’t any game shows called “Who wants to have £999,000”.

Usually the profiles of these doddery millionaires reveal they’ve been investing in their ISAs since TVs were in black-and-white, and/or they’ve been investing in ultra-concentrated portfolios which happened to hit the jackpot. We never hear about those investors who picked 10 stocks and are further away from being millionaires than when they started, though.

I’ve read a few of these ‘ISA maths’ types of posts before, and they always seem to use inexplicably unrealistic assumptions. “If you max out your ISA every year from when you start work at 21, then with 10% returns you’ll be a millionaire in less than 20 years.”

Well, yes, technically.

But most 21-year olds are struggling to scrape together enough money to buy such frivolous luxuries as food, water, and shelter. None of whom will be able to save anywhere near to £20k a year maxing out their ISA.

So I thought I’d show how it’s possible to become an ISA millionaire if you actually live on planet earth, and without ever maxing out your ISA.

A more realistic route to becoming an ISA millionaire

All numbers I’m going to be using here are real – i.e. both the growth rate and ISA contributions are after inflation. For the growth rate, I’m going to be using a 5% real rate of return.

This approach has three advantages.

Firstly, a 5% real rate of return is in line with long-term history, as shown in this post: ‘Return expectations: 2022 edition’. Granted, shorter-term expected returns for equities are lower than this (c. 5% gross), but given we’re thinking in a multi-decade time horizon here, longer-term returns are going to be more relevant than expected returns over the next ten years.

Secondly, by assuming both the growth rate and the contributions are stated in real terms, it means our future £1m portfolio isn’t eroded by inflation – it’s going to have exactly the same spending power as a £1m portfolio would have today.

Thirdly, using real figures gives us the ability better visualise how much future contributions would cost us, because all future contributions are expressed in today’s spending power. For example a £1,000 contribution in 10 years time will, because the numbers are after inflation, have the same spending power as a £1,000 contribution in today’s money.

Now let’s see if we can use some more realistic numbers than the usual “max out your ISA every year” approach:

These numbers look a lot more achievable at first glance, but we can use some statistics on average UK salaries by age to figure out how these levels of contributions stack up compared to average salaries.

Using median (50^th percentile) London earnings, which roughly equates to 75^th percentile in broader UK earnings, average salaries for each age band are below, alongside what percentage of the average salary is being contributed to the ISA each year:

Salary source: ONS

Obviously there are places to pick holes in these numbers. There will be flaws with any assumptions on salary/savings statistics. For starters, those percentages are of gross salary, not net – so would be larger when looked at as a percentage of post-tax income.

But overall these certainly seem more achievable, both in the value of the contributions made each month and the percentage of salary being invested, than the typical ISA maths articles.

At the end of the day, reaching £1m is a difficult job, and it’s going to require a high level of savings to get there. There’s no getting around it.

Whether or not you agree these are realistic or not I’m not sure. But I do know that the result is a portfolio worth £1m in real terms by age 65:

And that’s without ever contributing more than £12,000 a year. Given the limit is £20,000 a year for an ISA, becoming an ISA millionaire is achievable without ever coming close to maxing it out.

In this scenario, the total contributions over the 45 years total £369k. The final portfolio value in the 65^th year is £1,006,921. So the difference – about £630k – is free money from the market. That means 63% of the final £1m portfolio is generated by the magic money machine of compounding. The investor only contributed 37% of the £1m, and the market provided the rest.

What I thought might also be interesting was to look at the future value of each year’s ISA contributions. So here they are:

It’s a strange chart to get your head around, so here’s what it’s showing.

If you added up all those bars, you’d get the £1m final portfolio value. So the chart is showing that of that final £1m at age 65, how much of that comes from each year’s contributions. For example, our £3,000 contribution in our 21^st year ends up being worth just over £25,000 at age 65.

The graph does a good job of showing that a £250/month contribution aged 22 (a future value of £25,000) has just as much impact on your final portfolio as £450/month at aged 34, or £800/month at age 46, or £1,000 a month at age 50.

So the earlier you save, the less you have to save in the future to get to the same point.

I wanted to embed the Excel used for these calculations in this post, so you could play around with the assumptions yourself. Sadly my ineptitude with WordPress got the better of me, and because I didn’t fancy learning HTML, you’ll have to make do with my compound interest calculator. If anyone has any words of wisdom of how to embed editable Excel/Google Docs sheets, please let me know in the comments.

Saving earlier

Now let’s take a brief moment to conduct the classic experiment, and see what happens if we save slightly more slightly earlier in life. Again, nothing heroic, just a slight nudge of the needle.

What happens if you increase contributions between ages 21 and 29 by £50 a month?

Using our numbers from before, an increase from £250/month to £300/month between 21-29 results in an extra £40k at aged 65. If our investor instead waited, and saved that extra £50 a month at aged 40, an increase from £800/month to £850/month between 40-49 results in only an extra £17k.

The main point here is that increasing your savings earlier in life means more of your wealth is generated by the market, rather having to be contributed by you.

This chart puts it into perspective:

Investing £100 at age 21 results in the market growing that £100 to £900 – a return of 9x. Conversely, waiting 10 years until aged 31 to invest that £100 results in it being grown to about £550 – a 5.5x return. And waiting till aged 41 results in only 3.5x.

Bottom line: let the market do the heavy lifting for you.

Taking an extreme example of our ISA millionaire, if our 21-year-old somehow managed to save £550 a month until he was 39 (unrealistic, I know, but I’m making a point), and then saved the standard £800 a month between 40 and 49, he wouldn’t have had to contribute anything from ages 50 onwards to reach ISA millionaire status by 65.

And because he saved more when he was younger, 80% of the final portfolio value would’ve come from the market rather than his contributions. 80%! Of the final £1m, only £220k would’ve been made in contributions, and a whopping £780k was generated by the market. Those are some pretty astonishing numbers.

Now obviously I’ve exaggerated the numbers here to prove a point, but it really shows how beneficial increasing your investments earlier in life is.

Why invest?

I’m sure most of this blog’s readers will have heard all this before, but it’s worth re-iterating that investing earlier leads to three incredibly powerful outcomes:

1. You hit wealth goals earlier, and/or
2. You can afford to invest less later in life, and/or
3. You end up with a larger pot at retirement.

The main point is that it gives options. The option of retiring early. The option of taking a part-time job. The option of travelling more. The option of giving more. The option of deciding how you spend your time.

But this optionality comes at the cost of forgoing spending when we’re at our poorest. When we’re young is the best time to invest, yet it’s also when it’s the most difficult to save, and also when we derive the most benefit from some forms of spending. The older we get, the less likely it is we’ll be able to go hiking in Himalayas, or complete an Ironman, or kayak the Norwegian fjords. And we never know how long we’ll be around for.

So deciding when and how much to invest is a fascinating balancing act – on the one hand, spending when we’re younger is hugely rewarding. Nobody wants to spend their 20s and 30s stingily penny-pinching their way to financial freedom only to miss out on life. And nobody regrets spending money on travelling when they’re younger.

Even Warren Buffett, one of the Olympian gods of investing, said:

“It’s nice to have a lot of money, but you know, you don’t want to keep it around forever. I prefer buying things. Otherwise, it’s a little like saving sex for your old age.”

But on the other hand, we can’t always carpe diem to the max. YOLOing our earnings away each month is a sure-fire way to ensuring we’ll be shackled into a lifetime of indentured servitude (employment). Living paycheck-to-paycheck without any savings not only reduces optionality on how you spend your time in the future, but comes with the side effect of being life-shorteningly stressful.

And that’s one of the things which makes investing so interesting. We all need to decide how much value we place on our time now versus in the future. And we express that balance in how much we decide to spend or save.

Some will doggedly pursue the chance to retire early. Some would rather spend more now in the knowledge they may have to work a few more years later in life.

Ultimately there’s no ‘right’ way to do it – not everyone wants to be a millionaire.

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To summarise, I’m hoping this post has shown a few things:

1. You don’t need heroic assumptions to become an ISA millionaire. You don’t even need to max out your ISA. Yes, you need save – £1m is a big number. But with solid investing habits and time, it’s achievable.

2. The more you save earlier in life, the better. This is how you get the market to do the heavy lifting for you, and how you take advantage of all the free money on offer.

3. Don’t save sex for your old age.

If you have questions about how ISAs work, have a look at this post: ‘How many ISAs can I have?‘ which answers several common ISA-related questions, including what the different types of ISA are, how to transfer ISAs between providers, and (of course) how many ISAs you can have.