I’ve just received a charming little gift, and it isn’t even my birthday. Better still, I don’t have to acknowledge receipt or write a thank you letter. Unusually for a present, I know its exact value too – £69.99. Thank you, HSBC.
In your gift
Why did they send it to me? Because I hold units in its low-cost unit trust tracker HSBC FTSE All-Share Index Fund. The money was my latest share of the dividends paid by the 566 companies whose fortunes it follows. Now £69.99 isn’t much in the wider scheme of things, but it forms a small but essential part of my plan to build a pension pot big enough to fund a comfortable retirement.
In an ideal world that would be worth £1m, although being a realistic chap, I’ll settle for a little less than that.
Little by little
So how do I turn £69.99 into a million pounds? The brief answer is… slowly. This is not the only investment fund I hold. Over the years, I’ve accumulated stakes in more than a dozen different direct shares, investment trusts and index tracking exchange traded funds (ETFs), nearly all of which send me regular cash payments, just like HSBC does. Over the year, they add up to a good few thousand pounds.
Since I have invested through a Stocks and Shares ISA, I don’t have to pay any tax on that income, for the rest of my life. This will be basic stuff for many of you, but it’s quite remarkable when you think about it. Money out of the blue, and over time it really adds up.
Roll up! Roll up!
For example, I hold £10,000 in the iShares Core FTSE 100 ETF, which tracks the UK’s blue-chip index and currently yields 4.37% a year. This means the fund will pay me for £437 this year, again, for doing nothing.
The fund has an annual charge of just 0.07% so, in practice, I get £430. Still pretty good. Even if the stock market is completely flat that year, it will turn my £10,000 into £10,430.
If the fund also yielded 4.37% next year, it would pay me £448, after charges, lifting my total stake to £10,878. If I held it for 20 years, that would turn my original £10,000 into £23,211, even if the stock market did not grow at all over that time.
If I held it for 40 years (the type of term you should be saving for retirement) it would be worth £53,873. If I topped up the fund by £1,000 a year over that 40-year term, I would have £160,291.
There’s capital growth on top
Remember, this is what I get if stock markets don’t rise at all. History shows that over such a lengthy period, they’re likely to rise an awful lot.
The key to building your wealth is to reinvest your dividends for growth, because that way you’ll regularly buy more stock or units. These will also pay dividends, which you can reinvest to buy more stock, which pays more dividends, and so on, and so on — in an endless virtuous circle.
Too many investors underestimate the importance of dividends, and how much they contribute to your long-term wealth. In the longer run, they could be more important than capital growth. Over the years, they could help you build that £1m portfolio. And it all starts with small sums like my £69.99…
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Harvey Jones holds the HSBC FTSE All-Share Index Fund and iShares Core FTSE 100 ETF but doesn't have any position in other 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.