Many hard-working folks dream of retiring early. The monotony of the daily grind can be overwhelmingly dull and the hope of freedom is never far from the mind.
Wages are not rising, the cost of living is increasing, and people must work longer before they can claim a state pension, which is far from enough to live on in any case.
So, with all this taken into consideration, is retiring early even possible?
With some careful financial planning and commitment to an investment plan, there is a way to ensure wealth in your retirement years, through a passive income from the stock market.
A Stocks and Shares ISA can be a great way to get started on this path. The individual allowance for an ISA in 2019–20 is £20k per year, tax-free.
Although holding your savings in a Cash ISA is a safe way to save your money for emergencies, it’s not the most profitable way. UK interest rates are very low and have been for some time. It also doesn’t look as if they will increase soon. This means the value of your savings won’t grow and inflation could in fact cause their value to go down. Safe doesn’t necessarily equate with sensible when considering your long-term financial goals.
FTSE 350 index funds
The FTSE 100 is arguably the safest basket of stocks you could invest in because it consists of the UK’s 100 largest listed companies by market capitalisation. These are well-established companies with strong track records of making money and often returning extra to shareholders through dividends.
The FTSE 100 index has returned approximately 7% annually for the past 10 years, so investing in a FTSE 100 index tracker can be a good, consistent way to invest regularly.
Alternatively, the FTSE 250 is another popular tracker that contains the next 250 largest UK listed companies after the 100 in the FTSE 100. As they are slightly less established, they carry slightly more risk, but that goes hand in hand with a higher reward. The FTSE 250 has returned over 11% annually in the past decade.
The power of compounding
Some stocks and funds offer dividend yields, which make additional payments back to the investor at an agreed rate of return. For example, the FTSE 100 has a dividend yield of 4.4%.
If you reinvest those dividends, then your lump sum grows, and it gains interest on the increased pot. Gaining interest on your interest is called compounding and many fortunes have been made this way.
If time is on your side and you have a few decades before you aim to retire, then you can realistically hope to achieve a nice retirement nest egg, with a regular commitment to investing.
If you invest £20k in a Stocks and Shares ISA today and commit to continuing with a monthly £250 contribution, an average 8% annual return would mean you could pass the million-pound mark in 38 years. With £1m in savings, you could live comfortably on £50k a year for 20 years or £33k a year for 30 years.
Although, it’s possible to retire early thanks to the compounding effect of a Stocks and Shares ISA, how early depends on the amount you can afford to invest, the annual return you achieve, and how long you’re willing to wait.
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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.