The maximum New State Pension will give you an income of around £8,767 per year, which strikes me as being good for a crackers-and-cheese retirement rather than a steak-and-wine experience.
So, the need to build up a pot of money that you can use to improve your income in the Autumn and Winter of your life is probably a no-brainer. But I’d caution against squirrelling away your pounds in a cash-savings account whether it’s an ISA or not, because the interest rates they pay have been pitifully low for many years.
So low that it’s unlikely the spending power of your money will keep up with the corrosive effects of general price inflation.
And that is definitely not what you want. Instead of your saved money slowly losing its value, you need the capital in your retirement pot to be working hard. The first step towards that goal is to select an investment that gives you a return above the rate of inflation so that your money’s spending power is expanding on its own.
The ‘magic’ of compounding
The second step is to plough the money your capital earns each year back in so that it can earn a return as well – that’s compounding if you keep doing it, and it’s the principle that will propel you to a large and satisfying pension pot over time.
But instead of compounding cash account interest, I’d compound the returns from shares and share-backed investments. Right now, for example, the FTSE 100 index of the UK’s largest public limited companies has a dividend yield of around 4.5%, which knocks the spots of most cash savings accounts, even those that require you to tie your money up for years in order to get a higher interest rate.
Yet if you invest in an FTSE 100 tracker fund, you can withdraw your money if you need to with just a few clicks of your computer mouse in many cases. In that sense, investing in share-backed investments can be classified as ‘instant access’.
So, I’d set up a tax-efficient wrapper such as a Stocks and Shares ISA, Self-Invested Personal Pension (SIPP), Personal Pension or a Workplace Pension and make regular fixed monthly payments into it starting right away and not stopping until the day I retire.
If you select a Personal Pension or Workplace Pension your money will usually be invested for you by the provider into managed funds backed by a big element of shares as well as bonds in many cases. And if you choose the self-select route of SIPPs and Stocks and Shares ISAs you can choose your own investments.
Building an investment core
I’d start with a core investment in two or three low-cost, passive, and uncomplicated index tracker funds such as ones that follow the FTSE 100 index, the FTSE 250 index of London-listed mid-cap firms, or maybe the S&P 500 index consisting of many of the dynamic companies across the pond.
And in the wealth-building stage leading up to my retirement, I’d be sure to select the ‘accumulation’ version of each fund, which would ensure that my all-important dividends would automatically be reinvested to get the process of compounding off to a powerful start and propel me to the roughly £250k I think I’ll need to fund a doubling of my income from the State Pension.
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Kevin Godbold has no position in any share 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.