ISA season is approaching, and there are plenty of reasons why investors should choose to put their annual tax-free allowance into an Innovative Finance ISA (IFISA).
But one of the most compelling reasons is the speed at which you can use IFISA investments to build up a substantial nest egg.
In fact, according to Peer2Peer Finance News analysis, if you opened an IFISA account today, investing the full ISA allowance of £20,000 and earning a market-average rate of annual interest, it would take just 26 years to become an IFISA millionaire.
How does it work?
According to the most recent 4th Way Forecast Returns Index, the average P2P investor is earning 4.37 per cent per annum. If we use this as a guide, that would mean that by investing the maximum ISA allowance of £20,000 today, you would net £874 in interest in year one.
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Assuming the same average annual interest rate, by reinvesting this capital and interest, plus another £20,000 in year two, you would earn an extra £1,786 in interest.
If you repeat this formula, by the end of year three, you would have earned another £2,738.25 in interest, boosting your total IFISA pot to £65,398.45.
By year five, you would have sheltered more than £100,000 in the tax-free wrapper. And by year 15, your interest payments would start to outpace your annual ISA allowance.
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The £500,000 milestone would be reached in year 16, and just 10 years later your IFISA pot will have doubled in value to be worth approximately £1.045m. All completely tax free.
Of course, this timeline relies on your IFISA portfolio returning 4.37 per cent per year. In reality, defaults do happen, and platforms can always reduce their target returns depending on market trends. These risks can be minimised by diversifying your IFISA money across several different platforms, and multiple loans.
Similarly, most platforms offer target returns in excess of five per cent per annum, which would shave a few years off your IFISA millionaire timeline.
The most important thing to do is to be consistent. Start early and reinvest when possible in order to take advantage of compound interest. And always, always do your own due diligence in order to avoid investing in high-risk loans. After all, it’s better to earn a steady return of four per cent per annum for 26 years than spend 10 years chasing 20 per cent returns and risking a major loss.