If I was 30 and hadn’t got much in the way of retirement savings, I’d get stuck into the important job of building a second income for later life.
The good news is I’d still have another 35 years or more until retirement, which gives me plenty of time to make up lost ground.
No time to lose!
Time is a valuable commodity though, and I wouldn’t waste it. Money invested when still young works much harder than last-minute contributions, because it has longer to compound and grow. If invested in a Stocks and Shares ISA, it will work a lot harder than in a Cash ISA.
While many young investors choose to rely on a fund manager to pick stocks on their behalf, we at The Motley Fool prefer to buy individual company stocks to turbo-charge our returns.
Happily, blue-chip companies listed on the UK’s FTSE 100 pay some of the most generous dividends in the world, ideal for generating a second income. Some household names now offer yields of between 5% and 9% a year.
It’s impossible to get that kind of income from a savings account. ISA investors also have the prospect of capital growth on top, if share prices rise.
I would invest all the dividends I receive back into my portfolio while still of working age, as this boosts the compounding process. Then I would draw them as passive income when I finally retire.
So how much would I need to invest, starting from scratch at 30?
The easy answer is as much as I can afford, but I understand that’s not always possible. At 30, there’s rent to pay, bills to meet and debts to service.
Let’s say I invested a modest £3 a day, which works out as £1,095 a year. Let’s also assume I increased my contributions by 3% a year to keep pace with inflation.
Start early, stick at it
I’ll also assume my portfolio grows in line with the long-term average total return on the FTSE 100, which is around 7% a year. With dividends reinvested, my inflation-linked £3 a day would have grown into a pretty substantial £270,604 by age 67.
Under an investment rule-of-thumb called the ‘safe withdrawal rate’, someone who draws 4% of their portfolio each year as income will never deplete their savings. If I took 4% of my £270,604, mostly dividends, I would have income of £10,824 a year. That works out as £902 a month.
That’s not too shabby is it?
There is a drawback though. None of this is guaranteed. And in 37 years’ time, income of £10,824 a year will be worth less in real terms. To offset this, I would increase my contributions as I get older, when hopefully my income will be higher too.
Another danger is that my portfolio generates a lower annual total return of 7% (it could do better, of course). Yet by building a balanced portfolio of at least a dozen dividend-paying FTSE 100 shares in different sectors with different risk profiles, I should reduce the risk of underperformance.
The fun part is deciding which stocks to invest in. Fool.co.uk is full of top stock tips and that’s where I’d begin my hunt.
