No savings at 40? I’d invest £500 a month in UK shares within an ISA to retire comfortably

At the age of 40, we all enter our fifth decade. But there’s still enough time ahead to make decent gains for retirement if we invest £500 a month.

The ‘miracle’ of compounded gains

The key to building a decent retirement pot is the process of compounding gains. For example, If I invest £500 every month from the age of 40 and compound annualised gains of 7% from stocks, the arithmetical outcome looks like this:

The reason I picked an annualised return of 7% for this illustration is that many sources quote a figure in high single-digit percentages to describe the past performance of the general stock market. Of course, in reality, those returns won’t arrive in a neat straight line. Investing in stocks usually feels like two steps forward and one back with a few excursions around the houses along the way.

But if I keep the faith and keep investing every month, the chances are strong that pound/cost averaging will help to deliver a decent outcome in the end. And that outcome is worth having. One of the big takeaways for me from the above table is that, by year 20, the gains from my investments could be greater than the entire sum I’ve paid in.

And those end balances strike me as decent amounts of capital to use for generating a passive income in retirement. For example, I could put the entire £255,203 at the end of year 20 into an FTSE 100 tracker fund and draw the dividend income. Historically, the Footsie has yielded 4% and more. And a 4% annual dividend would give me an income of £10,208. I’d be comfortable on that If drawn alongside a State pension.

Keeping pace with inflation

However, I wouldn’t stop at £500 per month. As my salary increases over the years, I’d increase the monthly payments into my ISA. And that would ensure my investment pot preserves its real value and keeps pace with inflation.

But what investments should I choose for my ISA? One way of targeting that 7% annualised return is via simple, low-cost tracker funds. If the 7% represents the return expectation of the general stock market, trackers are a good way to capture those gains. I’d want to diversify between as many funds as possible. And the good news is, many trackers accept regular investment sums as low as £25. So, I could diversify between as many as 20 trackers when I invest £500 a month

I’d consider trackers following the fortunes of the FTSE 100, FTSE 250, and the UK’s small-cap companies. I’d also aim to track listed companies in America. But there’s room to be creative geographically, by sector and by niche, with plenty of choice on offer.

But having established that investment core, later on, I’d target higher returns than 7%. For example, I’d consider investment trusts, managed funds, and the shares of individual companies that own high-quality underlying businesses with growth potential.