Investing can be used to achieve many financial goals. And one of the most common is to help build funds for a more lavish retirement lifestyle.
Taking a DIY approach to the stock market isn’t for everyone. The process can be quite demanding both in terms of time and stress. After all, shares can be quite volatile, as everyone has recently been reminded. That’s why some may feel more comfortable outsourcing this wealth-building process to a pension fund or retirement planner.
These are all perfectly fine ways to build a retirement nest egg. However, cutting out the middleman could lead to superior returns for those who like getting their hands dirty. And, subsequently, that means more money for luxury holidays, housing, food, and hobbies.
Retiring with the FTSE 250
The London Stock Exchange is home to several market indices. Yet the FTSE 250 has so far proven to be the most lucrative. Since its inception in 1992, the index has delivered total annual returns of around 11%, even after all the recent stock market turmoil. And by investing in a low-cost index tracker fund, investors can replicate these gains for their own portfolios.
At this rate of return, consistently investing £250 each month for 40 years translates into a portfolio worth an estimated £2.15m. In other words, those who have just kicked off their careers have the potential to retire as multi-millionaires!
However, as exciting as this prospect sounds, there are a few caveats to consider when relying on index trackers. Just because the FTSE 250 has delivered double digit returns in the past doesn’t mean it will continue in the future.
In fact, as businesses mature, growth tends to slow. And this is clearly demonstrated by the FTSE 100, which has only mustered around 8% annualised gains over the same period.
But even if the gains remain intact, volatility is another factor to consider. More potential growth comes with added risk. And while the FTSE 100 hasn’t kept up with its younger sibling, the journey has been far more stable.
Future periods of prolonged market declines will likely hit the FTSE 250 harder. And investors may end up with significantly less than expected when retirement comes around.
Risk versus reward
It should be apparent by now that investing isn’t a risk-free endeavour. Even professionally-managed pension funds (which are required to stick to safer asset classes) can end up taking a nosedive. But despite their drawbacks, index tracker funds are arguably one of the most straightforward ways to build wealth in the stock market.
Stock picking is an alternative, more hands-on solution. While an index fund can never outperform its benchmark, a hand-crafted portfolio can potentially deliver far superior returns. And at the end of a long career, investors could have far more money in the bank. Even if a portfolio only manages to eke out another 1%, that’s enough to boost the previous pension pot estimate to £3m.
Of course, this higher performance once again comes with drawbacks. Portfolio management is no longer automated, and considerable time will need to be invested in researching which stocks to buy. And a poorly constructed or managed portfolio can spectacularly backfire.
But by taking a disciplined approach, stock picking can be far more rewarding. And that’s why it’s my personal preferred method.
