Both the Cash ISA and Stocks and Shares ISA allow investors to keep 100% of the returns they earn, free from taxes. But in terms of the possible returns, there’s a massive difference.
According to Moneyfacts research cited by AJ Bell, the average rate of return for a Stocks and Shares ISA over the past decade is 9.6% versus 1.2% for a Cash ISA.
Even if the next decade sees a better Cash ISA return (due to higher interest rates), it’s unlikely to surpass average stock market returns.
Of course, this isn’t an either/or situation, as many people hold both. One is essentially a tax-free savings account while the other involves investing in the stock market. The latter is riskier because individual shares don’t always rise — though the overall market does over time — and dividends aren’t guaranteed.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
The Cash ISA
Cash ISA rates are influenced by the Bank of England base rate, which is currently 4.75%. If an account is paying someone 4.5%, they would need about £133,500 in it to generate £500 a month in interest.
Starting from scratch and saving £10k of the £20k annual contribution limit, that would take roughly 11 years to reach. This assumes all cash is kept in the account along the way to fuel the compounding process.
However, rates are forecast to fall over the next couple of years as inflation stabilises. But how fast and when exactly is anyone’s guess. Therefore, predicting where rates will be in a decade’s time is impossible. They might be at 2%.
Investing in stocks
For an investor targeting higher returns then, a Stocks and Shares ISA is a superior vehicle. That’s because most providers offers a smorgasbord of investment options, including growth and dividend shares, various investment trusts, and exchange-traded funds (ETFs).
Assuming the average 9.6% return figure, it would only take around nine years investing £10k annually to reach the £133k target. At that point, an investor could switch to dividend shares yielding 4.5% to aim for £6,000 a year — or £500 a month — in passive income.
A higher-yielding portfolio of, say, 6% would generate an annual equivalent of £667 a month.
A share to consider
One FTSE 100 stock from my ISA portfolio that I think has excellent long-term growth prospects is Pershing Square Holdings (LSE: PSH). This is an investment trust that offers exposure to the hedge fund of star Wall Street investor Bill Ackman.
Hedge funds are typically reserved for wealthy individuals — those who might view the £20k ISA limit as pocket change! So this is a unique investment.
Between 2019 to 2023, Ackman’s fund returned 28% annually, handily beating the S&P 500. Over the past five years, the Pershing Square share price has rocketed 171% higher.
However, it’s important to note that Ackman manages an incredibly concentrated portfolio. The trust currently holds just 11-13 stocks. The risk here is that he loses the Midas touch and backs a handful of duds.
Top 5 stocks, as of November 2024
Portfolio weighting
Alphabet
14.9%
Brookfield Corp
13.5%
Hilton Worldwide Holdings
13.1%
Chipotle Mexican Grill
12.8%
Restaurant Brands International
12.8%
Looking ahead though, I anticipate market volatility with Donald Trump back in the White House promising widespread tariffs. Ackman tends to thrive in such choppy waters, exploiting the volatility to snap up long-term bargains and make bold moves.
The post How much would I need in an ISA to earn a £500 monthly passive income? appeared first on The Motley Fool UK.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Ben McPoland has positions in Pershing Square. The Motley Fool UK has recommended Aj Bell Plc and Alphabet. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
