It’s no secret that building a robust investment portfolio of high-quality UK shares is a recipe for building long-term wealth. Given time to compound, a collection of carefully hand-picked companies can grow into a six-figure money pot, even with only £250 a month. In fact, just matching the stock market’s average return is enough to build a £22,605 passive income stream in the long run. Here’s how.
Investing in growth before dividends
Dividends are an income investor’s best friend. The concept is pretty simple:
- The business produces excess cash
- There are no internal value-building uses for this extra money
- So management returns the proceeds to the owners of the firm (the shareholders)
However, the companies that can reliably generate the free cash flow required to pay dividends consistently are typically mature industry titans. And those aren’t known for delivering much growth. Therefore, instead of jumping in straight away with dividend shares, it might be wiser to initially focus on growth to build capital.
The FTSE 100 contains the largest UK shares on the London Stock Exchange. It’s known for its stability and generous shareholder payouts, with an average yield of around 4%. But even with dividends, the index has historically only delivered average annual returns of around 8%.
By comparison, the FTSE 250, which contains mostly smaller growth enterprises, has achieved closer to 10%. And in the long run, that extra 2% gain can be the difference between hundreds of thousands of pounds.
Generating income with UK shares
Let’s assume that the FTSE 100 and FTSE 250 continue to deliver the same average returns moving forward. How large would an investment portfolio become when injecting £250 each month for 30 years?
| FTSE 100 | FTSE 250 | |
|---|---|---|
| 5 Years | £18,369 | £19,359 |
| 10 Years | £45,737 | £51,211 |
| 15 Years | £86,510 | £103,618 |
| 20 Years | £147,255 | £189,842 |
| 25 Years | £237,757 | £331,708 |
| 30 Years | £372,590 | £565,122 |
Needless to say, turning £250 each month into half a million with UK growth shares is a rather tasty result. And transferring that wealth into a low-cost FTSE 100 index tracker could instantly provide a 4% yield, generating a £22,605 second income.
Of course, this assumes the investor only matches the FTSE 250’s historical performance. If they’re picking stocks successfully, the returns could be far superior, resulting in a much larger portfolio. However, as exciting as this prospect sounds, it’s important to realise the opposite is also possible.
Investing isn’t risk-free. Even the best businesses can become disrupted. Poor decision-making from investors reacting to volatility can very quickly destroy wealth rather than create it. And even if £250 is allocated to a FTSE 250 index fund each month, there’s no guarantee the growth index will continue to generate its average 10% return in the future.
All this is to say that investors may potentially end up with considerably less than expected. Nevertheless, the potential for unlocking a six-figure portfolio with a five-figure passive income makes these risks worth taking, in my opinion.
