When I’ve had enough of actively working for a living, I plan to live on the passive income generated by my investments. Yet building a big enough portfolio to fund a comfortable retirement won’t happen overnight.
Unless someone is lucky enough to have a juicy lump sum to begin with, or a kingsize income (neither of which applies to me), the wealth has to build slowly and steadily. I’ve been investing for more than 25 years, so I’m already some way there. But with another 15 years to go before retirement, I’m still going flat out.
I invest in two ways. First, by making regular monthly contributions. Second, by pumping in lump sums whenever I have cash to spare.
I started by investing in a few low-cost exchange traded funds (ETFs) to give me a broad spread of shares across the FTSE 100, the S&P 500, and emerging markets. Now I’m trying to turbo-charge my portfolio by investing in individual UK shares.
Thanks to recent volatility, now looks a great time to buy dirt-cheap, high-yielding FTSE 100 stocks like Aviva, Lloyds Banking Group, Glencore, and Taylor Wimpey. I buy whenever the market dips and reinvest all my dividends for growth.
Now let’s say I was starting from scratch at age 30. At that age, even a relatively small sum such as £100 a month has time to roll up into something much bigger.
Let’s assume I increased my contribution by 10% a year and my portfolio matches the FTSE 100’s average long-term total return of 8% a year. By age 68 I’d have built up an investment portfolio worth a staggering £1,216,884.
I’d have made total contributions of £436,852 and generated £780,031 in compounding dividend income and share price growth.
There’s a long-standing financial planning model known as the 4% rule, which states that if an investor draws that percentage of their savings each year their pot will never run empty.
I’ll leave some capital, too
If I followed that, my pot would generate £48,605 a year in retirement income. Unfortunately, that won’t be worth as much in real terms as it is today, thanks to inflation. But it should still generate a pretty decent return. If I need more, I can dip into my capital, although I’d rather leave that for my family.
Investing is a long-term game, and the earlier I get going, the better. If I didn’t start putting away £100 a month until age 40, I would only have £375,444 by age 68. That’s despite hiking my contributions by 10% a year and generating the same 8%-a-year total return as before. It’s amazing how much damage a lost decade can inflict.
Under the 4% rule, I’d only generate income of £15,018 a year. Although, that’s better than if I’d done nothing.
There are no guarantees with investing. I might generate less than 8% a year, I might generate more. There’s also the risk that the market crashes just before I retire. Although if it does, I would simply leave my money invested and wait for equities to recover, as they always do in the end. That way my portfolio will continue to generate capital growth in retirement, as well as all that passive income.