Many of my friends ask me if it’s possible that they could retire as millionaires. My simple answer is, yes. Even on a minimal income level, I believe people can become millionaires by retirement age if they start early enough.
“How is that possible?” they understandably ask. I reply that it’s through investing regularly and the magic of compounding returns. Let’s take a closer look.
Compounding returns
Let’s assume that you’re 25 years old with only £100 in savings and that you plan to retire at age 65. You invest that £100 and earn an 8% annual return. Then you make an additional £3,600 of contributions annually at the start of each year.
You have 40 years to invest. The annual return is 8%, compounded once a year. At the end of 40 years, the total amount saved becomes £1,009,384!
Saving £3,600 a year would mean being able to put aside about £300 a month or about £10 a day. Might you just be wondering if you should skip that next impulse purchase?
Investing later in life?
On the other hand, if you wait to start investing until you’re 30, you will have ‘only’ £671,446. The difference is due to the power of compound interest. This has a snowball effect on personal savings. As time goes on, interest leads to more money, over and over again.
In other words, if you start saving later in life, you have to save more each year in order to make up the difference. For example, if you start investing at age 40, then you would need to save and invest slightly over £1,000 a month to reach a million in your retirement account by age 65.
Ensuring a financially secure retirement
The full basic state pension is currently £168.60 per week. Do you truly believe you can live on that amount for the rest of your life after retirement?
It’s important to have a realistic view of how you can pay for a retirement of several decades. For example, I’d encourage you to contribute to your workplace pension scheme if you have one.
Every UK resident should also learn more about the different types of ISAs available to them, with an emphasis on Stocks and Shares ISAs.
My Motley Fool colleagues regularly cover FTSE 100 and FTSE 250 shares, as well as funds to consider adding to a diversified retirement portfolio. They point out that the stock market returns about 7% to 9% annually on average.
FTSE investment options
The FTSE 100 seems to be the initial index Britons mostly consider when they first start investing. It’s composed of the 100 largest companies, by market capitalisation, on the London Stock Exchange (LSE). The FTSE 250 is the next 250 largest companies and also has a number of investment trusts.
As you start learning more about the investment choices available, you’re likely to feel that some companies may be more appropriate for novice investors.
You may, for example, want to initially stay with large-cap shares as well as those with high (but reliable) dividend yields. Any capital gains delivered by the stock would be an added bonus on top of the dividend.
Another option could be to invest in low-cost exchange-traded funds (ETFs), which track popular stock indices both in the UK and globally. For example, if you’re interested in dividend stocks, then the iShares UK Dividend UCITS ETF may be an ETF to consider.
