Investors who take advantage of their annual Isa allowance could be on their way to becoming millionaires.
Research by comparison website 4thWay reveals saving £10,000 a year into an Innovative Finance Isa (IF Isa) could make you a millionaire.
IF Isas were launched in 2016 and allow you to invest in peer-to-peer loans tax free.
Peer-to-peer loans are where a saver lends their money to a borrower through a middleman website in return for a set amount of interest over an agreed period.
Analysis by 4thWay found that saving into peer-to-peer loans for 25 years could grow your savings pot to £1 million.
It says savers would have to invest £10,000 a year for 25 years and aim to achieve an interest rate of 9% a year to earn their million.
Those looking to take less risk could achieve the same sized pot by investing £20,000 a year and earning interest of 5%.
With peer-to-peer loans typically the more risk you take, the more interest you are paid. Higher-risk loans may be offered to individuals with weaker credit scores or to start-up businesses.
Neil Faulkner, managing director at 4thWay, says: “Interest of 9% is a tough target, but options do exist that could potentially enable you to achieve this while still controlling the risks.”
He says so-called asset-secured loans may offer the best opportunities for higher interest. These are loans which are backed by an asset such as property, which can be sold in the event the borrower defaults on the loan to recover some of the lender’s losses.
Mr Faulkner adds: “Anyone seeking to become an IF Isa millionaire needs time to enjoy their money too – you don’t want to take so long to grow your pot that inflation makes it meaningless. That is why you have to take bigger risks, but there is still no need to be reckless.”
Investors interested in peer-to-peer lending should use a website with solid, long track records and take the time to read about all the potential risks.
I have contacted 4th Way to ask how it calculated the returns and it has offered this explanation - it also has provided links online tools to calculate compound interest to check its sums. Here is its answer in full:
Perhaps the reader did not include a contribution at the start of the 25-year period, since in a straight arithmetic average compounding calculation the first contribution will grow the most.
Potentially, the reader also compounded differently and assumed either monthly contributions or contributions at the end of each investment period. We assumed a contribution at the start of every year, not the end, which better suits people trying to optimise by investing in IF Isas at the start of an IF Isa year, and we assumed annual compounding.
Online tools will help you calculate this without Excel or a calculator. There is MoneyChimp, which has been around for a very long time and is trusted by investors:
You would enter the following:
- Current principal: 10,000
- Annual addition: 10,000
- Years to grow: 25
- Interest rate: 9%
- Compound interest 1 time(s) annually
- Make additions at start of each compounding period
That should work out at the same as we calculated.
You can corroborate calculations elsewhere - for example. BankRate, which is also tried and trusted: