From a long-term perspective, one way to try and retire early would be to invest in a portfolio of blue-chip shares and reinvest any dividends along the way. Right now, I think there are quite a few cheap shares I could happily buy with that aim in mind.
If I had a spare £20,000 today and wanted to try and use it to build wealth over coming decades, here is how I would go about it.
Why are shares cheap?
Shares can be cheap for a variety of reasons. Sometimes they are in companies that have fallen out of fashion, or industries that investors are unnecessarily gloomy about.
But on other occasions, what seem like cheap shares have been marked down in price precisely because a business’s long-term commercial outlook is weak.
So when looking for cheap shares, I am careful to try and look for real value – and avoid value traps!
Finding stocks to buy
While that may sound straightforward in principle, putting it into practice can take some effort.
Consider my investment in British American Tobacco as an example. On one hand, the price-to-earnings ratio of just six for a company offering a 9% dividend yield makes this seem like a cheap share. But given the company’s high debt load and declining demand for cigarettes in many markets, will British American’s future profits remain as high as they are today?
That sort of dilemma is common when investing. But right now, I think a lot of well-known British shares really do look cheap relative to their long-term potential.
There are a number of pressures bearing down on London share valuations for now, from concerns about the British economy to a lack of international investor excitement when it comes to many British companies. I think that means there are some real bargains on offer.
Building income streams
If I had a spare £20,000, I could reduce my risk by spreading it across a range of companies. For example, I might split it between five to 10 different cheap shares.
A number of FTSE 100 shares in my portfolio currently offer high single digit percentage dividend yields. As well as British American Tobacco, other examples include M&G and Legal & General.
Imagine my £20,000 was invested at an average dividend yield of 8% annually. If I compounded those dividends, after 30 years my portfolio would be worth over £200,000. At that point I would be earning well over £1,000 a month on average in dividends.
That presumes flat share prices and dividends, which are never guaranteed. But by compounding dividends over the long term, I could hopefully aim to build a sizeable portfolio that could help me to fund an early retirement.
But the current opportunity to buy cheap shares might not last. A strong economy or renewed interest in the British stock market could push up prices. That is why, if I had a spare £20K to invest, I would act today to snap up some bargains for my portfolio.
