A Self-Invested Personal Pension, or SIPP, can allow someone to invest over the course of decades to help fund their retirement. Indeed, if they do that well enough, it may even enable them to retire early.
But whether that happens depends on a number of factors. One, of course, is how much they put into the SIPP. But another important factor is how they invest those funds.
Here are a couple of things I think can help improve the prospects of successfully building wealth in a SIPP – and one potential pitfall.
Starting as soon as possible
Pensions can seem far off for many people.
But retirement gets closer over time and that time can be very powerful if it is used to help build the value of the SIPP.
By taking a long-term view of investing and starting sooner rather than later, an investor can expand the opportunity they have not only to contribute to it but also to benefit from long-term compounding.
It can be tempting to put this off. But I think it makes sense to get started immediately, even if one only has a little bit of spare money to invest.
Treating risk seriously
Dreaming of a comfortable retirement is understandable. But while investing in the stock market can offer potential rewards, it also brings risks.
People know that but often they can suffer by underestimating some risks when choosing what shares to buy.
It makes sense to take risk management seriously. For example, easy steps in that direction can include sticking to what you know when investing and always keeping a SIPP diversified across a range of different shares.
Dividends can be attractive – but context is needed
One mistake some people make when investing a SIPP is thinking that if they buy some of the highest-yielding shares they can find and let the dividends pile up over the years, they will be able to build wealth.
Sometimes it works that way, so why do I see this as a potential mistake?
Dividends are never guaranteed and can be cut at any time. Meanwhile, dividends are only one part of what drives a share’s total return. It is also important to consider movements in share price.
As an example, consider Diversified Energy (LSE: DEC).
At first glance, its 8.2% dividend yield may sound highly attractive.
The dividend per share actually used to be higher than it is now, but even after a steep cut, that yield is still unusually high among UK shares.
But while the dividends have been chunky, what about the share price? Over the past five years, the Diversified Energy share price has fallen 57%.
That is not necessarily because of prices in the gas industry in which Diversified operates. British Gas owner Centrica has seen its share price more than quadruple in the same period.
The issue, as I see it, is the business model at Diversified. Its novel approach of buying up tends of thousands of aging gas wells has let it scoop up assets at potentially low prices.
But heavy borrowing has hurt the financial attractiveness of such an approach.
Dividends can help grow a SIPP’s value – but share price movements matter too!
