A lot of people would like to retire early. But rather than buying up gold or purchasing property to let, my approach involves acquiring small stakes in large blue-chip companies. I’m building a portfolio of FTSE 100 shares. And I think I could hopefully set up sizeable passive income streams that might help me bring forward my retirement by over a decade!
Taking a long-term approach
Retirement planning is a long-term activity. I therefore think it is well-suited to my similarly long-term approach to investing.
If I spend £500 each month buying blue-chip FTSE 100 shares in companies with businesses I understand, over 30 years that would give me a portfolio that had cost £180,000. It may be worth more or less than that depending on share price movements.
If I invested in shares paying dividends, it could also give me growing passive income streams over the course of three decades.
The current average yield on FTSE 100 shares is 4%. But I reckon that in today’s market I could aim higher while sticking to blue-chip shares.
Imagine my portfolio averaged an 8% yield, for example (the sort of dividend currently offered by shares including Legal & General and Imperial Brands). After 30 years, such a retirement pot should throw off £14,400 annually in dividends.
The power of compounding
But what if, instead of taking those dividends while still working, I simply reinvested them to try and grow my pension pot? That is something known as compounding.
Doing that, after 16 years, I would have a portfolio throwing off over £14,400 in dividends a year. In other words, by compounding my dividends, I could achieve the same annual income 14 years earlier.
If I wanted to boost my retirement income, I could put more than £500 in each month. The principle would still apply. Compounding the dividends would let me generate the same annual income much sooner.
Matching reality to theory
Now, a couple of caveats are worth a mention. In my example, I presume dividend yields are constant. But they probably will not be. They could move up, or indeed down.
Similarly, the example is based on consistent share prices when they too could move in either direction. That said, if they move up, it could hurt the yield on new shares but boost the overall value of my existing portfolio.
The point seems clear to me though. Compounding, as Warren Buffett says, is like pushing a snowball downhill. It gets bigger as it picks up snow that in turn picks up more snow. In this case, that snow is the dividends of FTSE 100 shares.
Finding shares to buy
Not all shares pay dividends and even those that do are not guaranteed to last. So I would not start by trying to find 8%-yielding FTSE 100 shares (although there are quite a few right now).
Instead, I would hunt for what I thought were great businesses with strong cash generation potential and an enthusiasm for paying dividends.
Then I would consider whether they are attractively valued and could be a good fit for my plan to retire well over a decade early!