Retirement may seem a long time away but it only gets closer. Putting money into a Self-Invested Personal Pension (SIPP) now and investing it in the right way could help me to retire with more cash to spend, decades from now.
If I wanted to aim for a million in my SIPP on retirement, starting with just £56,000 now and making no further contributions, here are the steps I would take.
Figure out an investment strategy
While going from a £56,000 SIPP to one valued in seven figures is possible, it is still a very challenging objective.
Rather than simply buying shares I thought could do well and blindly hoping for the best, I would start by deciding what investment strategy I planned to follow as I tried to turn my hopes into reality.
One approach might be to earn big dividends and reinvest them. Another could be to buy into growing firms with share prices I felt did not accurately reflect their long-term potential. Or I may want to mix up my SIPP and invest in both growth and income shares.
Take a long-term approach
If I want to turn a £56k SIPP into a million pound one over 20 years, I would need to generate compound annual growth of 16%.
If I had a 30-year timeline, I could achieve my target with a lower compound annual growth rate of 11%. With 40 years to spare, I could build the same million pound SIPP by compounding annually at 8%.
In other words, having time on my side could help me build my SIPP to the same level even with less ambitious investment returns. That is why I am a believer in long-term investing.
Finding the right shares to buy
An 8% compound annual return may not sound that tough. Right now, for example, I could earn a 7.9% annual dividend yield by investing in shares of financial services powerhouse Legal & General (LSE: LGEN).
But no share is risk-free. That is why I always keep my SIPP diversified across a range of businesses. Legal & General cut its dividend after the 2008 financial crisis, for example, although it has long since surpassed the pre-crisis level and has lately been growing at around 5% a year.
Compound annual growth is not just about dividends either. It can also be positively or negatively affected by share price movements. Over the past five years, the L&G share price has moved down 3%. There is a risk it could fall further, for example if another financial crash leads to clients withdrawing funds and profits falling.
But if I had spare cash in my SIPP today, I would happily buy Legal & General shares. It has the sorts of characteristics I like in a share I buy to hold, including a large target market, distinctive brand and cheap-looking valuation.
Buying the right shares at the right prices and taking a long-term perspective, I think my million pound target could be entirely feasible.
