A Stocks and Shares ISA with £20,000 in it could give me a welcome opportunity to invest in a range of great companies.
But might it realistically let me try and build wealth over the long term? I think the answer to that is ‘yes’.
Why a long-term approach matters
When I talked about building wealth, I was not focusing on this month, this year, or even necessarily this decade.
Instead I would treat my Stocks and Shares ISA with a long-term perspective. To understand why that is important, consider an analogy used by billionaire investor Warren Buffett. He compares investing to a snowball. As it moves downhill, it picks up more snow that, in turn, can pick up even more. So the snowball’s rate of growth increases over time.
The same applies to an ISA. Imagine that you achieve a compound annual growth rate of 5% on a £20,000 ISA. After 10 years, it would be worth around £31,000. After 20 years, it would be worth over £50,000.
But after 30 years, the valuation would be over £82,000. Each decade brings bigger returns even at the same growth rate. That is the snowball effect.
Risk and reward
With a long-term approach, I would not just focus on potential reward. Longer timeframes mean there is more time for risks to materialise too.
Buffett says that the first rule of investing is never to lose money and the second rule is never to forget the first one.
In other words, smart and consistently successful investors do not just look at the potential for a share to soar. They also always seriously consider the potential risks involved.
Growth and income
What would be better for my Stocks and Shares ISA in the long run? Buying into high-yield shares like Legal & General and Phoenix, or owning shares with the potential for the sort of explosive growth seen over the decades at firms like Amazon and Google parent Alphabet?
That is a difficult question and I am not sure there is necessarily only one right answer.
Owning the right Income shares could help me compound my earnings over time. But getting into a massive growth story at the right price might provide enormous returns.
One issue with growth shares is that, for every Amazon or Alphabet, there are lots of other companies that do not perform anywhere near as well. It seems obvious now that buying into Amazon 20 years ago would have been an investing masterstroke. But that was not necessarily anything like so obvious back then.
So I would be happy splitting my £20,000 between both growth and income shares.
In each case my focus would be on trying to maximise my potential long-term reward while keeping risks at a comfortable level. I would likely spread the £20K across five to 10 shares, to keep my portfolio diversified.
