If you’ve considered building an independent retirement savings pot to supplement the State Pension, you’ve probably considered investing in the stock market. No doubt you are aware of the line often trotted out in articles that shares have outperformed most other asset classes over the long term. So, you’re on board in theory, but where do you start?
Smart investing for busy people
Assuming you are youngish, you will have at least a decade or two to invest in order for the ‘magic’ of compounding to work for you. I’m also assuming you’re earning an income and that you’re busy juggling career, family and recreational commitments. In fact, you’re so busy you can’t imagine ever having the time to make a decent fist of investing on the stock market with all the research, monitoring and decision-making that would be necessary to succeed.
Contrary to what you might think, your lack of time for investing is probably your greatest advantage. You don’t have to Google for long to find plenty of claims and various bits of evidence that most private investors and active fund managers fail to beat the performance of the stock market indices. In many cases, not only do private investors and active fund managers fail to beat the market, they woefully underperform it.
So, by avoiding an active investing strategy you will have beaten most market participants already! That’s cool. You’ve already made the best first move by doing nothing, so feel free to put on your Ray-Ban sunglasses. And if there’s little chance of you beating the market, you might as well aim to equal the performance of the stock market by investing in a passive, low-cost index-tracker fund, such as one that aims to replicate the performance of the FTSE 100 index. If you do that, you’ll beat most private investors and active fund managers. Smart move. Mix another pineapple daiquiri and put your feet up.
Two ways to turbocharge your investment
But the FTSE 100 tends to lurch up and down, so how can we make any forward progress by investing in it? The answer is found in the dividend yield a FTSE 100 tracker will pay you. Right now, the yield is around 4.4%, and the way to make it turbocharge your returns is to select a tracker that automatically reinvests your dividend income back into your fund investment.
If you do that, the power of compounding will kick in with your reinvested dividends earning dividends, and so on in a virtuous cycle. But you can also use the weapon of pound/cost averaging to make the fluctuations in the index pay you handsomely.
To do that, refrain from investing all your money in one go and instead drip it into your tracker investment in stages — a payment every month would be ideal. That way, when the index falls, you will be buying more for your money, and when it rises you won’t be investing all your money at the highs.
In the short term, the index has always bounced back from its lows and, in the long run, I reckon the FTSE 100 looks set to perform well, anyway. Which, on top of all the compounding you’ve achieved along the way, could set you up in a comfortable retirement financially.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.