The State Pension is a safety net but isn’t enough to fund a comfortable retirement on its own. So I plan to generate a second income stream by investing in UK shares. Here’s my five-step guide to getting it right.
1. Start early
When investing, there is no time to lose. The first pound is the most valuable, because it has the longest time to compound and grow.
Let’s say I invest £10,000 in a FTSE 100 tracker aged 30 and it delivers an average total return of 6.89% a year. By age 67, I’d have £117,672.
Now let’s say I delayed five years and invested the same sum at 35. By 67, I’d have just £84,331. I’d have invested exactly the same amount and it would have grown at exactly the same speed. Yet I’d have £33,341 less.
2. Invest a lump sum
If I had a lump sum at my disposal, I’d spread my risk by purchasing a low-cost FTSE All-Share tracker. Then I’d start researching individual stocks in a bid to generate higher growth and dividends.
My most recent purchases include mining giant Glencore, private equity specialists 3i Group and consumer goods giant Unilever.
The risk with investing a lump sum is that if markets crash shortly afterwards, I’ll suffer an instant paper loss. Since I plan to hold all the shares I buy for a minimum 10 years, and ideally longer, that’s not really an issue. I have time to overcome short-term volatility.
3. Invest regularly
I’d also set up a direct debit to buy stocks out of my regular income. The money will leave my account without me really noticing but it will be working just as hard.
It’s possible to start with as little as £50 but I’d aim higher, say £250 a month and increase that by 3% a year to keep up with inflation.
4. Reinvest my dividends
Newbie investors often assume most of their return will come from rising share prices, forgetting that FTSE 100 companies pay some of the most generous dividends in the world.
Next year, the index is forecast to yield 4.4%. Around 20 stocks yield 5% or more. Fund manager M&G yields a staggering 9.66%. Dividends are never guaranteed so I always do my research to before buying to see if they are sustainable.
While working, I would reinvest my dividends to pick up more stock, and only draw them as income after I retire.
5. Give it time
Like a watched pot, a Stocks and Shares ISA portfolio takes time to come to the boil.
This tricks impatient investors into making rash decisions, such as selling stocks that don’t instantly shoot the lights out and chasing the next big thing instead. While it’s important to keep an eye on things, I won’t watch it too closely.
If I invested £250 a month and added a £5k lump sum once a year, after 30 years I’d have a thumping £1.09m, assuming growth of 6.89% a year. This also assumes I increase my contributions by 3% a year.
Nothing is guaranteed and I could lose money as well as make it. But if my portfolio of stocks yielded 7%, that could give me a second income of £76,160 a year, purely from UK dividend stocks with the State Pension on top.
