Possibly the simplest and cheapest way to invest in UK shares is to buy a low-cost FTSE 100 index tracker. It offers all the dividend income and share price growth generated by the UK’s blue-chip companies, in a single fund.
However, this hasn’t been the most rewarding strategy lately. The FTSE 100 climbed just 0.82% in the last year, although dividends would have lifted the total return to around 5%.
UK shares have fallen out of favour with investors, but I think this is a tempting opportunity. The UK market is cheap and when inflation and interest rates peak, it could quickly play catch up.
A simple way to build wealth
The FTSE 100 offers some of the most generous dividends in the world. In 2024, it’s expected to yield 4.4% a year, according to AJ Bell. That makes it a good way to generate income for my retirement.
A single person needs £23,300 a year to enjoy a ‘moderate’ living standard in retirement, according to the Pensions and Lifetime Savings Association. To be ‘comfortable’, they need £37,300. I like a bit of comfort, and will aim for that.
The full new State Pension currently pays £10,600 a year. After subtracting that, I need to generate £26,700 a year myself. I would need capital of £606,818 to generate that, if I only invested in a FTSE 100 tracker.
This assumes I only draw my 4.4% yield, and leave the capital intact. Savers aged between 55 and 64 have on average £107,300 in their pension, official figures show, so that’s quite a tall order.
If I downgraded my retirement income expectations to ‘moderate’, I’d still need £12,700 a year from my FTSE 100 tracker. In that case, I’d need a pot of £288,636. So how hard is it to save that kind of money?
Over the last 20 years, the FTSE 100 has delivered an average total return of 6.89% a year. Let’s say my retirement was still 30 years away and I invested £400 a month (increased by 3% a year to keep up with inflation). That would give me a total return of £653,367, easily surpassing my target.
Here’s why I target individual stocks
However, if my retirement was only 20 years away, I would need to up my starting contribution to £1,000 a month. That would give me £654,458, using the same assumptions. Clearly, the earlier I start investing, the easier it is.
In practice, I prefer to buy individual FTSE 100 stocks than a tracker. Today, Aviva, Rio Tinto and Taylor Wimpey yield from 7.5% to 8.5%. I’d happily buy any of them.
If my portfolio of direct equities yielded, say, 8% a year, I would only need £333,750 for a comfortable retirement, and £158,750 for a moderate living standard. That looks more doable.
The risks are elevated when buying individual stocks and dividend income is never guaranteed. However, by investing for the long term, in a basket of at least 15 shares, I would hope to generate higher rewards while limiting the risks, allowing me to retire in style.
