How to invest through an ISA to build wealth in the UK
Investing is not just for rich people
Quite the opposite.
Investing is how most ‘normal’ people get rich, but this is not a ‘get rich quick’ scheme - this is ‘get rich over decades’.
If you haven’t started investing, it feels intimidating and scary. It feels a bit ridiculous for us to do it because we’re not trained professionals.
It’s thoughts like these that keep most UK people from investing. And this results in most UK people being much poorer than they would be if they just did what you’re doing now - peeking behind the curtain.
Once you get into this topic, you’ll feel like you’ve been given a cheat code with money, but you’ll need 15 minutes to digest this so only carry on if you have the time and are feeling fresh.
The ‘future you’ will thank you for doing this properly because this will change your life (promise).
There are two reasons to invest
The chart below is one of our favourites.
It looks like it could be showing some crazy crypto thing going from hero to zero. But it's actually showing the great British pound, and its real value from the year 1200 until today.
£1 back then would get you what £2,000 does today because in that time inflation has eaten away at the value of those sweet, sweet pounds.
As someone who earns money, you need a way to protect your money from the corrosive forces of interest rates - and investing is pretty good at doing that.
The stock market has out-performed the effects of inflation for over 100 years. Basically, money in the stock market has grown quicker than inflation has eaten away at that money.
There have been years (and even periods like the 1980s) when inflation has outpaced the stock market. However, the general long-term trend is in investing's favour - which brings us onto the second reason to invest - to buy your freedom.
A big misunderstanding most people have with money is they think its purpose is to buy the things you want or need. This is the wrong way to look at it.
We see the money we earn as a thing that can work for us. Once you have money you can put it to work for you through investing, so that it's making more money for you, 24/7, 365 days a year.
The point is to do that until one day you have so much money that you can stop working and let the money keep working for you. At that point you are financially free.
Money is not just something you need to live and consume. It is a tool that can set you free.
What happens if you invest £5k in the stock market?
When Andrew Craig told us this example in the second ever episode of our podcast (video at the top), it blew our minds.
Imagine you had a great Aunt Agatha who died just before you were born and left you £5k.
Then imagine you get a return of 10% a year (which is what the US stock market has delivered on average for 100 years) - how big would your £5k be in 55 years (the legal age you can withdraw from your pension at the time of writing)?
£945,000, without you doing anything, pre-inflation. Basically a million quid!
This is the power of compounding.
Our human brains struggle to grasp exponential growth.
Legend has it that the inventor of chess once took the game to the Emperor of India who was so impressed he asked the inventor to name his reward.
The inventor said: “I only wish for this. Give me one grain of rice for the first square of the chessboard, two grains for the next square, four for the next, eight for the next and so on, for all 64 squares, with each square having double the number of grains as the square before.”
The inventor of chess was essentially asking the Emperor to compound his return at 100% for every square on the board.
How many pieces of rice would the Emperor give the inventor in total?
Well, on the 64th square alone it would be 18,000,000,000,000,000,000 grains of rice. We don’t even know how you’d say that number out loud.
This is what you’re buying into when you start investing.
Compounding is a way for you to build wealth, without doing anything - apart from giving it time.
It’s a light bulb moment when you realise how wealthy you can become through investing, so start playing around with this compound interest calculator. What happens if you invest something every month and get 8% - 10% a year for 20, 30, 40 years?
You can see how £5k turns into nearly £1m at 10% a year in the chart below:
The biggest challenge you’ll face is yourself
You can see from the chart above how important time is - so much of the growth happens in the later years.
Think of compounding like a snowball rolling down a hill. It starts small but then grows and grows.
The key is to not interrupt the snowball because you need to give it time, but that can be difficult when you’re investing because of human psychology. Here's why.
We mentioned the American stock market has grown at just over 10% a year for a century. You can see that here:
The chart^ shows the returns of the largest 500 companies in America for the last 100 years.
But although the long term trend has clearly always been up, there have been many short term downturns along the way which aren’t easy to see when you’re so zoomed out.
Check this graph:
This chart shows exactly the same data of the US stock market, except it’s represented on a yearly basis.
Every year the US stock market grew is shown in green, whilst years the market dropped are shown in red.
The American stock market has returned about 10% a year on average - but look how bumpy the ride was. Hardly any year produced a return of 10%.
As an investor, it’s crucial you’re prepared mentally for the ride. It's not like a bank account that pays you a certain amount in interest every month - and this volatility can mess with our minds.
You have to withstand the short term dips. Seeing your money going down, in those red years, is painful and often leads to rash actions. But you have to withstand those red years if you want to enjoy the green years, which historically have delivered life-changing returns - but only over the long term.
One of the biggest mistakes new investors make is they think investing will get them rich quick. They then chase big returns and buy a load of rubbish, like Chinese EV companies that have never made a car or meme coins.
The other big mistake that new investors make is running for the hills when the market dips. They sell rather than hold and keep buying (when the markets are down, the price just got cheaper so is generally the time to buy not sell).
The emotion of seeing the money you've built going down causes mistakes in red years, but you need to withstand those periods so you can get the overall benefit of the green ones. In this episode, you can hear how someone in our audience, Amy, fell into these psychological traps, which cost her big time.
Trying to time the market is a mug's game. Case in point - over the last 30 years if you missed the best ten days, the size of your portfolio would be halved. How are you supposed to guess those right?
This is why the biggest challenge you’ll face is yourself. The hardest part of the style of investing is staying consistent, continuing to invest and not selling when those red years come.
But if you can withstand that short term volatility, then long term passive investing will change your life because on a long enough time horizon, 8% - 10% a year grows a little into a lot. Go on, have a play with that compound interest calculator if you haven't already.
By the way, all these numbers are pre-inflation which is very important - we talk more about that in our overview of pensions.
How do you invest?
So how do you get a slice of this juicy action?
Well, a way to invest in the US stock market is to invest in the S&P 500 which tracks the 500 biggest companies on the US stock market (that’s the thing that delivered those 10% pre-inflation returns).
The S&P 500 is an example of an index fund. So is the FTSE 100, which you may have heard of.
These are weird finance words that sound confusing but are actually pretty simple. They are just lists of companies. For example, the S&P 500 is a list of the biggest 500 public companies in America, compiled by a company called Standards and Poor's (which is why it’s called the S&P 500). They produce a list of what they think are the biggest 500 companies on the American stock market. You will recognise a lot of them like Apple, Microsoft, Facebook, Tesla etc.
Whenever you hear the word ‘index’ just think of a list. The FTSE 100 is the Financial Times's list of the 100 biggest companies on the UK stock exchange.
Index funds are magical because they allow you to invest in hundreds, or thousands of companies through just one investment.
They make investing very simple. You can pick an index fund and set up a monthly payment to invest in it and then forget about it to let it compound (that’s where the phrase ‘set and forget' comes from).
But it’s not just about how easy index funds make it for normal people to invest. They generally deliver incredible results - better than most professional investors over the long term.
This knocked us for six when we first heard it but 95% of professional investors don’t beat the market (index funds) over a 10-year period (watch this episode).
By design, index funds put more money into the top performing companies whilst getting rid of lower performing ones, e.g. by removing them from the index. They perform natural selection on your investments constantly. It's more nuanced than this but index funds basically back the winners and not the losers.
They do this passively rather than actively. This means they automatically list the most valuable public companies that fit their criteria rather than choosing individual companies - which is what active fund managers do (professionals).
For example, if the 501st largest American public company becomes more valuable than what was the 500th largest, then it will enter the S&P 500 at the expense of the other. If you are invested in the S&P 500 then your money will start being invested in the new entrant which is essentially growing faster (it's more valuable) than the previous company. And this all happens automatically.
Another benefit of index funds is because they passively pick the biggest companies that fit their criteria, their fees are generally lower than active funds - which improves returns because they cost less.
The end result is index funds give people a really simple way to grow wealth over the long term. And it means normal people can invest without trading.
Trading is basically evaluating individual companies (or other assets like gold) and buying and selling them in a short space of time.
Investing (at least the passive style we’re talking about) is just picking an index fund or two and then investing in them every month for decades.
Investing is consistent, long term, low effort and often boring. Trading is the opposite.
We think everyone should invest over the long term (if they’ve built an emergency fund) because it delivers life changing returns without much thinking. But we think very few people should trade... and what's the point of trading when most professionals don't beat the market long-term anyway?
We’re big fans of investing in global index funds because they allow you to invest in thousands of companies all over the world through one investment.
We like them because we’re essentially betting the world will keep growing, which it has historically done at 8.5% a year on average for the last 100 years.
You can of course invest in the US market which has been the best performing market for the last century.
But we like global index funds because we don’t need to try to predict huge economic trends like if the US will fall from dominance. For example, anyone who thought the Japanese market was going to be the global winner in the late 1980s (as lots of people did) would've lost big time.
When you're investing in a global index fund you don't need to be right about whether one nation is going to win. If any country wins, you win, because you're backing the globe.
It's also worth noting that American stocks account for about 65% of global index funds at the time of writing so you're still betting on America if you buy a global index fund, but you are giving space for the possibility of other economies coming to the fore.
We like global index funds because they're simple, we don’t have to make difficult decisions about the world and can just ride a strong long-term trend of global growth. We like them because they're low effort and the rate of return they've delivered is enough to get us where we need to be long term.
That’s what we think, but you need to figure out what you think. Do you believe in global growth? American growth? Or something else?
Once you have, you’ll be able to find an index fund which captures what you think and then invest in that one thing.
But we’re not gonna lie, even though this might make sense in theory, when you get to the actual investing part, it can be really confusing because there are so many terms.
How to pick your platform and funds
The most important thing is just to get started. You can make changes over time as you grow more comfortable but it's getting over that initial hurdle which is so hard but so vital.
If you're worried about losing money (there will be red years but you've gotta be in it for the long haul!) then try investing a £1 and seeing what happens in 6 months.
With this style of investing - passive index funds - you can only lose what you put in. And you really can start with as little as a £1.
Once you've decided on the kind of index fund you want to invest in (e.g. a global one), you then need to choose the specific fund and the platform (otherwise known as a broker) to use.
Picking a fund and platform is difficult to cover properly here so we've made this episode (video below) including a glossary of terms so you can assess your options.
Below are some of our favourite brokers (also known as platforms) - places where you can actually make investments. FYI some of these are affiliate links but we genuinely like and use all of them:
Trading 212
You'll get a free share worth up to £100 when you sign up for a new ISA or Invest account and deposit at least £1 with this link.
If you do not get your free share after depositing at least £1, use the promo code ‘MM’ (for our podcast Making Money).
You can use this code for up to 10 days after opening the account.
InvestEngine
You'll get up to a £50 bonus when you invest at least £100.
Vanguard
Minimum investment of £500 or £100/month. This is not an affiliate link.
Invest through a stocks and shares ISA so you don’t pay tax on gains
We’re very lucky in the UK to have tax efficient vehicles like ISAs and pensions to help us build wealth without being taxed to high heaven.
This is vital because the average UK household will pay over £1.2m in taxes over a lifetime. Yeah, bonkers.
You may have heard of an ISA but it’s a national tragedy that most ISAs in this country are cash ISAs and not stocks and shares ISAs.
We have a whole episode on ISAs here but the key thing to know is they’ll save you from paying tax on your investment gains.
An ISA is a tax efficient wrapper for things you hold within it. Think of it like a shoe around a foot.
The foot might be cash or stocks (like index funds) - and the shoe is the tax wrapper which protects the foot - in this case your investments - from any further taxes.
In the example where you’ve turned £5k into nearly a million pounds, you don’t want to pay tax on that gain if you can help it - you want to keep the million quid.
That’s exactly what would happen if you’d used an ISA - then you could keep all the gains, tax free.
So when investing in the UK, the general guidance is to invest through a stocks and shares ISA first - which you can do up to £20k/year. You’re still investing in the same stuff you would be through a general investment account - but you’re protecting those investments from tax.
Opening an ISA is really easy. Once you've chosen your platform (make sure they offer ISAs first) you can open an ISA with a few clicks. Here's that episode again with a step-by-step guide.
Key actions
Invest what you can every month consistently into the same thing, like a global index fund.
We like investing in global index funds (which invest in thousands of companies around the world) because we don’t need to predict which individual stocks or economies will go up or down. Instead we’re just betting that the world will keep growing because it always has done over the long term. It’s low effort and has given the long term return we need.
Invest first through a stocks and shares ISA because you’re not taxed on any gains you make. You can invest £20k/year through an ISA.
On any given day, month, or year, the markets can be down, but in the long term, historically, the market has always gone up. This is why you should take a long term view with investing (at least 5 years, ideally decades) because you don’t want to pull your money out when the market is down - that’s when you lose money. This is where your emergency fund comes in. You need to withstand the red years to enjoy the green ones. If you can, set it and forget it.
PS - we mentioned Andrew Craig, from our second episode. He wrote probably our favourite British book on personal finance, How To Own The World. If you just read two books on this subject, we’d suggest that and The Psychology of Money.
This is not financial advice. The reason it’s not financial advice is because it’s not tailored to you. We are here to talk about the principles of building wealth but if you want personalised help, it’s worth speaking to a financial advisor - you can learn more here. As with everything financial, please do your own research. We really encourage that because no one cares more about your money than you and if you learn the basics then it’s life-changing.
If you purchase a product or service using one of the links above, we may receive a small commission. There will be no additional charge for you. Remember investments can fall and rise - and past performance is no guarantee of future results. Other fees may apply. Your money is at risk.
