It’s easy than ever to start investing. We can create an account in a matter of minutes. Some platforms don’t even require us to deposit starting capital.
But how could I go about building a portfolio to generate annual income worth £117,784?
It requires consistency, discipline, and patience (such a pot could take decades). Let’s take a closer look.
Regular saving
If I don’t have any starting capital I need to commit to a regular savings schedule to build my investment portfolio. This is a disciplined approach to investing that allows me to gradually build my portfolio while taking advantage of pound-cost-averaging and compounding.
These days, it’s much easier to start investing with very little money due to the availability of fractional shares, low-cost investment platforms, as well as online guides and investing resources. Not only has investing become more financially accessible to individuals with less disposable income, online resources have democratised investing.
I could start a portfolio with as little as £2 a day, or even less. But if I really want to build a sizeable portfolio, I’m going to need much more than that. For the sake of this example, I’m going to assume £300 a month. This could be split with my wife, or I could cover it, depending on my financial position.
I’m also going to want to set up automatic savings. By doing this, individuals can ensure a regular flow of funds without the need for manual transfers or decisions. It also encourages a systematic approach while eliminating the risk of forgetting or delaying contributions.
And finally, I’ll want to use the ISA wrapper. That’s because any future income will be tax free.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Harnessing the power of compounding
Compound returns is the process of growing an investment by reinvesting the returns (normally dividends) year after year. Obviously, some companies don’t pay a dividend because they reinvest in their own business, thus allowing the investor to benefit from compounding without having to do anything.
Compounding might not sound like the best strategy, until it dawns on you. Growth is exponential because I’d be earning interest on my interest as well as my original investment. In many respects, compound returns is like a snowball rolling down a hill. It starts small, but as it gets larger, it grows quicker as it picks up more snow (interest).
The amount of annual income I can receive from my portfolio will depend on how long I save and reinvest for, and the annualised returns I can achieve. A Warren Buffett-esque performance could see returns as high as 12% a year, turning my £300 a month into a huge portfolio worth £1.04m after 30 years (but of course, inflation would reduce its value compared to today).
And the bigger the portfolio gets, the more income it will generate. Here’s how it could look depending on the previously stated variables.
| 6% returns | 8% returns | 10% returns | 12% returns | |
| 5 years | £1,101.66 | £1,538.08 | £2,014.37 | £2,534.12 |
| 10 years | £2,741.83 | £4,054.95 | £5,637.38 | £7,543.83 |
| 20 years | £7,938.31 | £13,391.23 | £21,405.97 | £33,178.96 |
| 30 years | £17,392.77 | £34,114.43 | £64,092.20 | £117,784.80 |
Of course, there’s a catch. If I invest poorly, the value of my investments could fall instead of rise. As such, I need to do my homework, maybe even search out some share tips, and then make sensible investing decisions.
