Looking ahead to retirement is something many investors start doing too late. But the earliest start to opening an ISA to save for retirement, the more powerful the long-term financial benefit can be.
To illustrate, imagine I put £500 a month into my ISA and compounded its value at 9% annually. Doing so 15 years before retirement would mean I had an ISA worth around £183,000 when I stopped working. Doing exactly the same, but starting 15 years earlier, means I would enter retirement with an ISA valued at around £851,000.
In other words, double the timeframe in this example gives far more than double the results, using the same investing technique. That reflects the power of compounding.
Using compounding to build wealth
So what kind of companies ought I to hold in my Stocks and Shares ISA if I want to try and compound at that sort of rate?
The answer is I need to choose very carefully. That 9% might not sound like much – and in a good year, a lot of shares will grow by more than that. But remember that the 9% here is a compound annual growth rate, meaning an average of 9% every year overall (my example here uses a 30-year timeframe).
Based on that, a 9% compound annual growth rate is harder to achieve than in one or two good years. But it is possible.
Both share price growth and dividends (that I would reinvest) could help my ISA increase in value over time.
Choosing superstar shares
Whether from growth or income shares, what I look for would be surprisingly similar. In short, a business with a proven model that allows it consistently to generate substantial excess cash.
Maybe it pays that out as a dividend or maybe it retains it inside the business. Either way, hopefully, buying the right share at the right valuation could help my ISA grow substantially in value over the long term.
As an example, consider the supermarket chain Sainsbury’s (LSE: SBRY).
The retailer has had a solid five years, with the share price increasing 43% during that period. On top of that, the dividend yield is 4.7%. Remember though, that is the yield based on the current price. If I had bought the shares five years ago when the share cost less, my investment would now be yielding 6.7%.
Sainsbury’s has a lot of what I look for in an investment. It operates in a market with strong demand that is likely to last over the long term. It has a large customer base and encourages ongoing custom through its brand, loyalty programme and a network of stores that for some shoppers offer a convenient location.
Profit margins in grocery retail are thin and have got thinner over recent decades. Ongoing tight competition could keep squeezing margins – and profits.
If I could buy Sainsbury’s at the right price though, I would be happy to hold the share in my ISA.
The current valuation is a bit rich for my tastes however. Still, other shares benefit from competitive advantages in resilient markets – and an attractive valuation. Finding them now could help me substantially boost the future value of my ISA.
This post was originally published on Motley Fool
