The Motley Fool

Here’s how you could retire as a millionaire

Close to 50% of workers, when contemplating their retirement years, regret not having stashed away enough cash for their old age. When I left my very first job after four years, instead of transferring the small pension I’d built into my new employer’s scheme, I chose to take the cash and spend it instead, and then I started afresh.

A key part of that regret is not starting soon enough. Those first few years of pension savings, compounded over all of the following years, would be worth far more to me now than the same amount saved over the last four years.

The early years are crucial

Suppose you had a working life of 40 years, and you invested £100 per month at an annual return of 6% for the first five years, and then you moved jobs and didn’t invest a further penny. After five years you’d have accumulated slightly under £7,000, and a further 35 years of compounding at 6% per year would turn that into £53,700.

Another worker who only started saving 22 years before retirement, and then put away £100 per month at the same 6%, every month for the whole period… they’d end up with almost exactly the same amount. Your first five years of investing would be worth the same as their 22 years of effort — thanks to your 35 years of compounding.

ISA millionaires

Would you believe there are probably more than 200 ISA millionaires in the UK today? While company pensions and SIPPs provide one route to retirements savings, making the most of your annual ISA allowance is a great way to provide for your old age — especially as all that lovely share price growth is tax-free.

The new allowance from April this year stands at £20,000, and if you’re fortunate enough to be able to invest that full amount every year at an annual return of 6%, it would only take you 24 years to reach a cool million — and only 19 years if you could achieve 10% returns.

Suppose you can’t invest that much, what would it take to achieve a millionaire’s retirement in a 40-year career? The answer is £6,300 per year, or £525 per month, at 6% returns.

Dividends do it

These examples assume all dividends from your shares are reinvested, but surely taking a bit of that cash each year to spend won’t do any harm, will it? After all, you’ll still have your shares appreciating for decades. Don’t be tempted, because it can kill your performance.

The Barclays Equity-Gilt study has been comparing annual returns from shares, cash and bonds for more than a century, and shares beat other forms of investment hands down. But the study also shows the benefit of reinvesting dividends, and it’s quite astonishing.

If you’d invested £100 in the UK stock market in 1945 and spent all your dividends, you’d still have a very nice £9,148 after adjusting for inflation — more than 90 times your original investment. But if you’d reinvested all your dividends in new shares, you be sitting on an inflation-adjusted pot of a stunning £179,695.

What shares should you buy?

I always suggest FTSE 100 companies paying reliable dividends as cornerstones of a retirement portfolio, and that includes ones like BP with its 6% dividends, Taylor Wimpey currently offering 8%, Legal & General and SSE also on 6%, and AstraZeneca offering 5.5%.

Then all you have to do is dream about that comfy old age you’ll surely have ahead of you.

You really can become a millionaire

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended AstraZeneca, Barclays, and BP. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.