Is it possible to build a million-pound pension pot in just 13 years?
There's an old joke about a lost motorist who pulls over to ask a local for directions to a nearby town. The local replies, "I wouldn't start from here if I were you!"
This came to mind when I read 'The great pension challenge' in the Sunday Times of 2 August. The article is about 47-year-old Mark Strahan, who first posted his idea on one of the Fool's discussion boards. Through a combination of investing and trading, Mark has a bold and daring plan to turn £36,000 into a cool million by 2022.
Mark is doing better than most
When it comes to pension provision, self-employed workers are usually at the bottom of the heap. Mark is a self-employed IT consultant, so he has to make his own pension arrangements. However, I believe that he's already well ahead of the general population.
For more than 20 years, Mark has been contributing £100 a month into a personal pension with Norwich Union, now Aviva (LSE: AV). These contributions have created a pot currently worth £120,000. Given that the average personal pension pot at retirement is around £25,000, he's already well ahead of most self-employed workers. That's the first piece of good news.
The second piece of good news for Mark is that his personal pension has a guaranteed annuity rate (GAR) of 11%. Thus, his pot will produce a pension of roughly £13,000 a year when Mark reaches 60. At 11% a year, Mark's GAR is hugely valuable, as it's more than twice current annuity rates of around 5% a year.
In other words, to buy a pension of £13,000 without his GAR would require a hefty £260,000. So, in effect, Mark's GAR makes his pension much more valuable than first appears. On top of that, this fund could grow further by the time he decides to draw an income from it.
Do-it-yourself pensions
Mark also has £36,000 in a self-managed, do-it-yourself pension known as a self-invested personal pension (SIPP). He created this by transferring in a previous Scottish Life pension. The majority of this -- £33,000 -- is now invested this into shares in various blue-chip companies, including Barclays (LSE: BARC) and Tesco (LSE: TSCO).
Also, Mark has put aside £3,000 in his SIPP in order to pursue a high-risk, high-reward strategy designed to make his SIPP worth £1 million by the time he reaches 60 in 2022. So, Mark has 13 years in which to increase the size of his pot by £964,000. What this means is that Mark's pot has to be 28 times as big as it is now in order to be worth £1 million.
Can it be done?
For Mark's pension to leap from £36,000 to £1 million in 13 years, he will need a compound annual growth rate (CAGR) of 29% a year on the whole amount. Let's be generous and assume that he makes a steady 10% a year on the £33,000 invested in big firms. After 13 years, this will have grown to £113,925.
Thus, to build a million-pound SIPP, Mark's trading pot of £3,000 would need be worth £886,075 by 2022. For this to happen, Mark needs achieve a CAGR of 55% on his £3,000. The problem is that the historic return of the UK stock market as a whole for the last century or so is under 11% a year. In other words, for Mark to succeed, he must beat the market return by a factor of five. This would make him the greatest investor and trader in financial history!
Some of the greatest money managers in history (men such as Warren Buffett of Berkshire Hathaway, George Soros of Soros Fund Management, Julian Robertson of Tiger Management, Peter Lynch of Fidelity Investments and Bill Miller of Legg Mason) have produced annual returns of 20%+ over extended periods. But not one of these greats has achieved a CAGR of 55% for 13 years in a row.
I admire Mark for aiming so high, but I'm pretty certain he'll end up missing his target. His mechanical strategy seems to have an elegant simplicity, as do all mechanical and theoretical strategies. Mark puts the full £3,000 into the shares of one company and cashes in when the share price has risen by 11% to 15%. Conversely, if the shares fall by 15% to 20%, Mark will cut his losses and sell. After each trade, the proceeds will be invested in another company. He carry on this process until 2022.
55 heads in a row
Mark reckons that he needs 55 successful trades in a row -- or roughly one per quarter -- in order to pull off this mighty feat. As an IT consultant, I'm sure that he is good at maths and has done his sums.
The problem is getting all those winners on the trot. The kind of luck or skill needed would be akin to throwing 55 heads in a row, which is possible but has never happened to my knowledge!
Markets don't move up smoothly in straight lines. Instead, they are subject to periods of intense fluctuation. For example, since the turn of the century, the FTSE 100 index has halved, doubled, halved again and then risen about 33% since its low this March. These kind of wild gyrations play havoc with even the most ingenious trading strategy!
My advice to Mark is simple: put back your retirement to 65 instead of 60; make the highest monthly contributions you can to your SIPP or another investment such as an ISA.
Assuming Mark continues to keep us updated (he's posted some initial trades already) following his progress is going to prove very educational. He's being sensible in that he's keeping the majority of his SIPP in solid blue chip shares and only risking a small part of his wealth in this high-risk strategy. I wish him the best of luck.
> You can follow Mark's (alias ukpoker) trades on the Fool's Investment Strategies board.
> Keep your trading costs down with The Motley Fool's Share Dealing service. Opening an account is free and real-time trades cost just £10.
